Tuesday, July 21, 2009

Why Inflation May Be The Threat Of The Future

James Hamilton of Econbrowser from his chapter in The Road Ahead for the Fed:

The reason I find that loss of Fed independence to be a source of alarm is the observation that every hyperinflation in history has had two ingredients. The first is a fiscal debt for which there was no politically feasible ability to pay with tax increases or spending cuts. The second is a central bank that was drawn into the task of creating money as the only way to meet the obligations that the fiscal authority could not. Every historical hyperinflation has ended when the fiscal problems got resolved and independence of the central bank was restored.

Surely it is not far-fetched to suggest that the U.S. faces a profound political challenge in using spending cuts or tax increases to meet its current and planned fiscal obligations.

I think the current debate makes clear that we already have the first ingredient for a hyperinflation. It remains to be seen if we can avoid adding that critical second half of this recipe for disaster.

No comments: