The Inflation Spiel From Paul Krugman

Keynesian high priest (and Nobel awardee) Paul Krugman appears to be conditioning the public of a possible turnaround in his outlook!

He writes,

The Fed could directly finance the government by buying debt, or it could launder the process by having banks buy debt and then sell that debt via open-market operations; either way, the government would in effect be financing itself through creation of base money. So?

Well, the first month’s financing would increase the monetary base by around 12 percent. And in my hypothesized normal environment, you’d expect the overall price level to rise (with some lag, but that’s not crucial) roughly in proportion to the increase in monetary base. And rising prices would, to a first approximation, raise the deficit in proportion.

So we’re talking about a monetary base that rises 12 percent a month, or about 400 percent a year.

Does this mean 400 percent inflation? No, it means more — because people would find ways to avoid holding green pieces of paper, raising prices still further.

I could go on, but you get the point: once we’re no longer in a liquidity trap, running large deficits without access to bond markets is a recipe for very high inflation, perhaps even hyperinflation. And no amount of talk about actual financial flows, about who buys what from whom, can make that point disappear: if you’re going to finance deficits by creating monetary base, someone has to be persuaded to hold the additional base.

At this point I have to say that I DON’T EXPECT THIS TO HAPPEN — America is a very long way from losing access to bond markets, and in any case we’re still in liquidity trap territory and likely to stay there for a while.

Krugman admits that the Fed can directly “finance the government by buying debt” and indirectly “launder the process by having banks buy debt” which can cause HIGH inflation.

But yet he engages in subtle sophism by saying this won’t happen for as long as the US has access to bond markets—”very long way from losing access to bond markets”.

Obviously losing access to bond markets isn’t the issue, if the Fed continues to buy US debts!

And that’s exactly what the Quantitative Easing (QE) programs are for. And QE represents no more than a shell game. In other words, such shell game is happening NOW!

Here is the statement of the US Federal Reserve announcing QE 2.0 last November (CNN Money)

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The point is as Krugman continues to talk of inflation he prepares the public for that dramatic announcement where he’d probably mimic his idol, “When the facts change, I change my mind. What do you do sir?”

This should represent another MAJOR failure of the macroeconomic paradigm.