Wednesday, June 10, 2009

Laffer on inflation

Writing in The Wall Street Journal, Arthur Laffer joins the list of economists who are worried about inflation in the future.
Alas, I doubt very much that the Fed will do what is necessary to guard against future inflation and higher interest rates. If the Fed were to reduce the monetary base by $1 trillion, it would need to sell a net $1 trillion in bonds. This would put the Fed in direct competition with Treasury's planned issuance of about $2 trillion worth of bonds over the coming 12 months. Failed auctions would become the norm and bond prices would tumble, reflecting a massive oversupply of government bonds.
If we do not see any inflation in the next two years, monetarists will be challenged to explain why. On the other hand, they will look pretty good if we do see it. It is as if the Fed was conducting an experiment to test economic theories. Plus the Obama administration is conducting another experiment about supply-side economics.

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