Inflation is Not the Problem

Last week, I linked to Paul Krugman's Robbins Lectures from LSE. In the three talks, Krugman gave a detailed analysis of why inflation will not be a problem in the near term. His argument, and it is a powerful one, is that we are in a liquidity trap in which neither zero interest rates or the type of quantitative easing that most governments are engaging in is likely to lead to price increases. In brief, inflation is not the problem.

Indeed, in a reversal of the argument in the U.S., our central bank governor, Mark Carney was warning the Harper government last week not to ease up on stimulus out of fear of inflation. And in fact, this was reflected in news that our banks are piling up excess reserves as they are reluctant to loan and consumers are reluctant to borrow.

Much of this fear arises because long term rates and mortgage interest are rising, as this chart from economics blogger Ajay Shaw shows



This morning, former Fed vice-chair Alan Binder, writing in the New York Times, presents his argument. He notes first, that deflation will remain the far greater danger for at least the next two years, second, that the Fed and other central banks are well aware of inflationary dangers and will take action before the economy returns to full capacity and finally that rising long term interest rates (and mortgage rates) are merely a return to normal following historic lows.

What few are commenting on (Krugman is the exception here) is the ideological nature of this debate. Our Conservative government and Republican opposition in the U.S. are eager to return to their fiscally conservative roots. And as Krugman constantly reminds us, and as Bernanke as an historian of the Great Depression should know, the return to balanced budgets and tight money in 1937 led to a second depression that was only ended by war.