Where’s the inflation? The calls have come tauntingly, from the usual suspects. The Keynesian economists who warned of deflation in the aftermath of the 2008 financial crisis are trying to declare victory now, pointing to falling price levels as evidence that they were right. The most illustrative example is a recent blog post by Paul Krugman, the New York Times columnist, entitled, “What Have We Learned?” The post featured one chart showing a decline in inflation since late 2008, and another showing a decline in the rate of interest paid on ten-year Treasury notes. “The other side declared that we were in imminent danger of runaway inflation,” Krugman scoffed, “and that federal borrowing would lead to very high interest rates.”
The first link — “imminent danger of runaway inflation” — takes readers to a May 2009 op-ed by Carnegie Mellon University economist Allan Meltzer, author of the acclaimed History of the Federal Reserve. Nowhere in the op-ed did Meltzer warn that runaway inflation was “imminent”; in fact, he specifically stated:
When will it come? Surely not right away. But sooner or later, we will see the Fed, under pressure from Congress, the administration and business, try to prevent interest rates from increasing. The proponents of lower rates will point to the unemployment numbers and the slow recovery. That’s why the Fed must start to demonstrate the kind of courage and independence it has not recently shown.
I phoned Meltzer to ask him about Krugman’s distortion of his work, of which Meltzer was unaware. “I don’t read him,” he said. “And I wouldn’t attempt to convince Paul Krugman, because he has a set of beliefs that he won’t give up.” The kinds of policies Krugman has been advocating lately — e.g., more quantitative easing from a Fed that has already over-extended its balance sheet — are precisely the kinds of policies Meltzer was warning against, and Krugman is offering precisely the justification that Meltzer predicted.
The danger of an inflationary fire, as Meltzer took pains to note, was not imminent in early 2009. Rather, his point was that the Fed and the U.S. Congress had done the equivalent of laying an enormous amount of newspapers and gasoline around a house that was not exactly fireproof to begin with, making it vulnerable to two possible sparks: (1) An economic recovery could begin in earnest, leading banks to start lending out the nearly $1 trillion dollars in excess reserves the Fed had pumped into them; or (2) a big domino in the sovereign-debt markets — Japan, say — could fall, sparking a re-pricing of sovereign debt across the board and a spike in U.S. borrowing costs.
On the first point, some note that the Fed has recently started paying interest on reserves. If interest rates start to rise, tempting banks to loan out their reserves, the Fed can offer them a similar rate in order to keep them from flooding the economy with new money. But Meltzer doesn’t believe this strategy is likely to work. In an op-ed for the Wall Street Journal last January, he noted that politicians want banks to lend the money. The demand for the Fed to keep interest rates low — including the rate it pays on reserves — will be strong, as Keynesians such as Krugman encourage the Fed to put concerns about unemployment ahead of concerns about inflation.
In this context it is worth remembering that, after the tech bubble burst, Krugman cheered on the Fed’s disastrous policy of using easy money to fight the ensuing recession, even as he acknowledged that the logical endpoint of the policy was “a housing bubble to replace the Nasdaq bubble.” It is also worth noting that most measures of inflation do not include home prices, but rather use a “rent equivalent” measure to incorporate the cost of shelter into most price indices. Thus, most measures of the general price level completely missed the enormous flood of cheap money into real-estate speculation. If a sudden doubling or tripling of the price of housing doesn’t constitute a form of inflation, what does?
On the second point, the risk of inflation stems from the concern that, in the event that a crisis of confidence precipitated a sudden increase in Treasury’s borrowing costs, the Fed would print money to fund the deficit rather than allow the U.S. government to default on its debt. Such an event could have any number of triggers, but Krugman tells us not to worry about the “invisible bond vigilantes.” It would be one thing if Krugman had a better track record of appropriately evaluating the risks associated with his preferred fiscal and monetary policies. But he doesn’t (see above).
In other words, the fact that we haven’t seen inflation yet isn’t proof of anything, much less proof that critics of our current fiscal and monetary policies are wrong. Meltzer is correct that it’s pointless to try to change Krugman’s mind. But it’s important to keep pointing out how his ideology blinded him to the risks of his brand of recession-fighting before, and to note that those risks are present — and growing — today.
– Stephen Spruiell is an NRO staff reporter.