Inflation at Cato

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Here is a letter by a Senior Fellow of the Cato Institute, published in the Financial Times, April 23, 2009, that favors an inflationary policy by the Fed under present conditions.

From Mr Jagadeesh Gokhale.

Sir, The article by Martin Feldstein (“Inflation is looming on America’s horizon”, April 20) was poorly titled. Prof Feldstein does not forecast higher inflation. His caution about future inflation is predicated on future Federal Reserve actions. For inflation to become a problem, the Fed must accommodate it by failing to retire recent increases in bank reserves as the economy recovers. It is noteworthy however that Prof Feldstein follows the well trodden sequence of economic recovery followed by inflationary pressures that the Fed must combat.

Under current conditions, however, I would suggest that the sequence be reversed – at least temporarily. The present economic malaise is associated with insufficient expectations of price increases in key sectors such as housing. Home prices and other items associated with home ownership (rents, property taxes, home insurance, and maintenance costs) comprise a significant share of overall inflation metrics. And homes are good hedges against inflation. No inflation, indeed, expectations of negative inflation would mean few prospects of future home price appreciations that confer tax advantages in the US. That causes potential home buyers to remain on the sidelines.

Recent massive injections of bank reserves by the Fed are probably intended to reverse expectations of price declines. Under current conditions, slightly higher inflation and inflationary expectations could be the very balm essential for pulling the economy out of recession. Of course, it remains true that the Fed must later ensure that demand-driven inflation does not spin out of control. But that’s a balancing act for the future, the need for which would not arise unless the economy recovers. Currently, price increase expectations appear to be a precondition rather than a hindrance to achieving an economic recovery.

Jagadeesh Gokhale,
Senior Fellow,
Cato Institute,
Washington DC, US

10:28 pm on April 27, 2009