As you know, from September 2008 to September 2009, the Federal Reserve pumped an unprecedented $2 trillion into the financial system by buying Treasury bonds and assets from banks. According to most mainstream economists, such action should create a general increase in prices. Yet, strangely, according to these same mainstream economists, there are no signs of inflation. In fact, the fear is deflation. How can that be explained?
I have tried to tackle this question in my Reason column this month. My overall conclusion is that economists need a new paradigm to understand inflation today. Think about it this way: In the 1970s, economists couldn’t understand what inflation was about and how to get the country out of the vicious spiral of stagflation. That’s until Milton Friedman turned the field of monetary theory upside down. Since then, economists agree that inflation is always and everywhere a monetary phenomenon.
The same revolution needs to take place today.
While the current monetarists learned from Friedman the idea that we should fear inflation, in practice central banks’ biggest fear is deflation. As a result, economists who are theoretically inflation-hating Friedmanites now want to meet every downturn by fighting deflation. Translation: The Fed has spent a lot of time in the last 20 years creating bubbles.
Virtually all economists now agree, for example, that the Fed’s low interest rates inflated housing prices earlier in the decade. Yet as the prices of houses went up, few economists worried about inflation because the CPI looked relatively stable, due in part to a decrease in energy prices. When housing started to crash in 2007, many economists thought the Fed should inject still more funds into the system to stave off further declines. They failed to see that the Fed had distorted relative prices in the first place.
Plus, how can economists be missing the fact that inflation is already here? For all of you out there with big lines of credit, with variable rates based on prime, it’s time to pay it down before the rates start increasing big time.
My article is here. Also, here is a great piece by Allan Melzter.