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Politics : Politics for Pros- moderated
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From: LindyBill1/1/2009 8:51:12 PM
   of 793919
 
How to keep away inflation in the future
MARGINAL REVOLUTION
By Tyler Cowen on Economics

Larry, a loyal MR reader, asks:

>>>When the US government borrows and prints so much money in the coming few years, how is the country going to keep massive inflation away?<<<

Borrows and prints are different here. The borrowed money is no inflationary threat, if the U.S. government is willing to raise taxes to pay it off.

As for the newly created reserves, in theory the Fed can suck them out of the banking system at will (and/or change the rate of interest paid on reserves, to influence demand to hold). But will it hit the right timing in practice? Let's say the economy miraculously recovered tomorrow. Banks would be very eager to make more loans than they are doing now and the broader monetary aggregates would go up rapidly. However the broader aggregates take many months to influence the price level, so in the meantime the Fed would sell assets from its balance sheet and take reserves out of the economy. These are uncharted waters and the trial and error factor likely will be significant.

It is the lags which give the Fed some chance to react but the lags also mean that the Fed will never quite know if it is proceeding at the right pace. And will the contractionary open market operations be conducted with all the non-standard assets currently on the Fed's balance sheet?

As I said, uncharted waters.

I give it a reasonable chance that we, in due time, have a secondary recession, resulting mainly from the Fed deflating at too rapid a pace as the economy recovers.
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