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Inflation is Already in the Cards

By: Steve Johnson

5/5/2009 - 14 Comments

Some economists think that inflation is not a problem and the government is doing the right things to avoid deflation.

These economists think that we are more likely to be fighting deflation as asset prices like houses and cars continue to drop with unemployment. 

Although it is true that we will continue to see liquidation prices from over produced assets like houses and cars for several years, inflation is already built into the economy.  The question is not will we have inflation, but how soon will we have inflation and how high will it get.

Here is a quote from an interesting opinion article by Allan H. Meltzer, a professor of political economy at Carnegie Mellon University.  The article begins with a look at how the current administration’s policies are reducing production and savings.

“It doesn’t help that the administration’s stimulus program is an obstacle to sound policy. It will create jobs at the cost of an enormous increase in the government debt that has to be financed. And it does very little to increase productivity, which is the main engine of economic growth.

Indeed, big, heavily subsidized programs are rarely good for productivity. Better health care adds to the public’s sense of well-being, but it adds only a little to productivity. Subsidizing cleaner energy projects can produce jobs, but it doesn’t add much to national productivity. Meanwhile, higher carbon tax rates increase production costs and prices but do not increase productivity. All these actions can slow productive investment and the economy’s underlying growth rate, which, in turn, increases the inflation rate. “

Some argue that the Fed needed to lower interest rates to stop deflation. The article goes on to explain why it is nearly impossible for the US economy to experience deflation.

“Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation. “

The day is quickly approaching when the Fed will be forces to increase interest rates in the face of the deepening recession as inflation starts to show its true momentum.

“The proponents of lower rates will point to the unemployment numbers and the slow recovery. That’s why the Fed must start to demonstrate the kind of courage and independence it has not recently shown.”

By definition, inflation is the expansion of the money supply.  Without a doubt, the Fed has been increasing the money supply by the trillions – which will eventually be reflected in higher prices.

The wave of inflation that is coming is going to match the historical levels of increase in the money supply.  The only way to stop inflation is to reduce the money supply, and that is done be reversing the interest rates are taking back the bailout money that was added into the economy.  Both of these will further devastate the economy.

There is no easy answer to inflation.  It should have been avoided at all costs – even if that means a deep recession.

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