Why Inflation Will Occur

Greg Ip, long-time Fed analyst, describes in The Economist what he terms the Fed’s last two options, both of which he claims to be politically toxic:

The Fed is not helpless; it has two powerful tools left—but both are politically toxic. One is unsterilised foreign exchange intervention: buying foreign currencies with newly printed dollars, as the Swiss National Bank has done to hold down the franc. This would both stimulate net exports by pushing down the nominal value of the dollar, and alleviate deflation pressure by pushing up the price of tradable goods. (In theory, unsterilised intervention expands the money supply and ultimately, raises the price level, so the real exchange rate is unchanged even if the nominal exchange rate falls.) But the Fed won’t do this without the Treasury’s approval, which for its part doesn’t want the rest of the world accusing it of exporting its deflation. The other tool is a money-financed fiscal expansion: the infamous helicopter drop of money. Buying bonds on the secondary market, as the Fed already has done, stimulates demand only by lowering interest rates. Unless the banks take the money they got in exchange for the bonds they sold to the Fed, then plough it into other, riskier assets (like loans), there’s no direct boost to aggregate demand. By contrast, buying newly issued bonds specifically to enable the federal government to spend more money would be a powerful boost to demand.

I don’t disagree with Mr. Ip’s assessment regarding the two options. I do disagree with the term “politically toxic.” That is a relative term. How politically toxic would these two alternatives seem to be if the alternatives were not sending out Social Security checks or Medicare reimbursements?  Of course, they would become politically palatable and necessary if such a trade-off were to arise. It will and they will do one or both of Ip’s politically toxic acts, only because the alternatives are much worse. That is why we are heading for uncontrolled inflation.

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