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Will the Fed choose to inflate?

The Washington Times has a good article on the Fed and inflation:

www.washingtontimes.com/news/2010/feb/19...

It raises several interesting points, including the following:

The US resorted to inflation (and real GDP growth) to reduce a high debt/GDP ratio after World War II. Inflation was the more important of these two factors.

Some respected economists, including Ken Rogoff, have been openly advocating higher inflation as a way to reduce the debt/GDP ratio. The Fed would adopt inflation targets in the 4% to 6% range.

China is already reducing the duration of her Treasury holdings by concentrating purchases in the short end of the curve.

Here are some thoughts of my own:

Even though Mr. Hoenig may be a nuisance it is clear that the Fed has accepted to be a follower in the Stackelberg game it plays with the Treasury (the leader). That is, the Fed will accomodate whatever level of deficit by running the printing press. (A Fed in the leader position would steadfastly refuse to accomodate, forcing the Treasury/follower  to cut deficits or see a collapse of the bond market)

If large holders like China are already wise to the inflation strategy then there is little benefit from inflation. Players are much more sophisticated than they were in the years after World War II. The only way to collect large inflation tax revenues is to continuously surprise the big players, like China, Japan, and the oil countries. But this means hyperinflation.

The bottom line: the US is between a rock and a hard place. Inflation remains the least painful solution to the debt problem, but it is not clear if it is a feasible solution.







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