By Clive Crook
Published: September 13 2009 19:52
Is it too soon to worry about rising prices? Inflation hawks have been speaking up in the US lately, but are not getting much of a hearing. “The economy is still limping, job losses are still rising, and consumers are still reluctant to open their wallets. So it’s the perfect time to worry about inflation?” asks the New Yorker’s James Surowiecki incredulously in a recent column.
He tries to take the idea seriously, but not very hard. The economy has plenty of spare capacity; productivity is surging; inflation expectations – from the interest rate on US inflation-indexed bonds – are low, he points out. “Then why are people afraid that inflation is about to get out of control? Because they’re always afraid that inflation is about to get out of control.”
This is not even about economics, he reckons. It is a kind of twisted moralism. Inflation hawks are puritans obsessing over monetary turpitude and the debasement of the currency. Many are Republicans. Best ignore them.
Fear of inflation can be taken too far, but this is complacent. It is too soon to worry about inflation in the same way it was too soon in 2005 to be concerned about securitised mortgages and house-price bubbles. The US economy’s immediate problem is indeed stagnant output, not surging prices – but you do not need extraordinary foresight to see how this could change.
Monetary and fiscal policy both need to stay loose for now, but a little thought about the next big economic-policy challenge would not go amiss.
At the very least, you have to acknowledge that the Federal Reserve faces an entirely new set of problems. This is not just because the recession has been so severe, but also because its interventions during the course of this crisis have been unprecedented in range and scale.
In providing support to the financial markets, using all kinds of new tools, the central bank has massively expanded its balance sheet. For the moment, therefore, ordinary monetary-policy rules do not apply. Later, a different problem arises. As the economy recovers, this support will need to be unwound, otherwise rising inflation will indeed result. Exactly how this should be done is far from clear.
The outlook for US public borrowing makes everything worse. To see why, note that the Fed has taken on implicit fiscal responsibilities as part of its response to the crisis. You have heard of tax avoidance: this was constitutional avoidance. Congress was unwilling to give the Treasury the resources it needed to support the markets, or to authorise on anything like the required scale the transfer of risk from troubled financial institutions to US taxpayers. The Fed, relying ultimately on its ability to print money and the fact that it is not expressly forbidden to act as it did, stepped in with trillions of dollars.
One should not ignore an obvious parallel: the US long-term fiscal deficit poses a similar problem. It has deteriorated so markedly that the government’s ability to finance it must be in doubt. The administration rightly calls its own projected numbers for public debt unsustainable. But how exactly is the budget gap going to be closed? Resistance to broad-based tax increases is one of the few things that Democrats and Republicans agree on. And forget what the Republicans say about spending cuts: their record on this is even worse than the Democrats’.
During the crisis, given the political barriers to the fiscal action needed, the path of least resistance led to the Fed. Might the same not happen again, when the US has to confront the consequences of its fiscal choices? This is no longer a theoretical possibility: a line has been crossed. The US would not be the first country to resort to the printing press under such circumstances. Inflation expectations look firmly anchored today. If the prospect of a monetary solution to the fiscal problem starts to loom, the anchor will slip.
A lot will depend on how quickly the Fed can get back to business as usual. Several chapters in a timely new volume of essays edited by John Ciorciari and John Taylor* look at the Fed’s exit strategy. A paper by Donald Kohn, Fed vice-chairman, offers reassurance. The central bank is aware of the risks, he says; it designed its interventions to minimise them; it has not compromised its independence, and will jealously guard it in future.
That is what you would expect an inflation-fixated central banker to say – and quite right too.
But James Hamilton of the University of California more plausibly argues that the Fed’s independence has already been “seriously compromised”. He goes on: “That the Fed should find itself in a position where Congress and the White House are viewing its ability to print money as an asset to fund initiatives they otherwise couldn’t afford is something that should give pause to any self-respecting central banker.”
Grappling with the unwinding of its interventions would be hard enough for the Fed in any event. Justified anxiety about long-term public debt will make the task of managing inflation expectations, and hence the operation of short- and medium-term monetary policy, even harder. Congress and the White House could help by coming up with a fiscal consolidation plan ready to deploy once the recovery is secure. Inflation is not an issue yet, but sometimes it pays to think ahead.
*The Road Ahead for the Fed
Copyright The Financial Times Limited 2009
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