4 Reasons Why Bernanke Will Refuse to Fight Inflation

With recent news of inflation rising in Australia we turn an eye to the same eventuality at home in the US. Despite overwhelming growth in the monetary base, little inflation has yet to appear in government measures. Not that we’re one to trust those…

Inflation’s unlikely to keep at bay much longer. To date, banks have been hoarding new money pumped into the system as excess reserves (to protect themselves against grotesque losses like the $7.6 billion Citigroup reported losing last quarter). However, banks will again begin to lend once they feel there’s room to maneuver, and the resulting burst of growth in the money supply will lead to rapid inflation.

Recently, accepting this likelihood, Harvard economics professor Gregory Mankiw outlined three reasons why Bernanke’s still going to refuse to fight inflation.

From The New York Times:

“First, a little bit of inflation might not be so bad. Mr. Bernanke and company could decide that letting prices rise and thereby reducing the real cost of borrowing might help stimulate a moribund economy. The trick is getting enough inflation to help the economy recover without losing control of the process. Fine-tuning is hard to do.

“Second, the Fed could easily overestimate the economy’s potential growth. In light of the large fiscal imbalance over which Mr. Obama is presiding, it’s a good bet he will end up raising taxes for most Americans in coming years. Higher tax rates mean reduced work incentives and lower potential output. If the Fed fails to account for this change, it could try to promote more growth than the economy can sustain, causing inflation to rise.

“Finally, even if the Fed is committed to low inflation and recognizes the challenges ahead, politics could constrain its policy choices. Raising interest rates to deal with impending inflationary pressures is never popular, and after the recent financial crisis, Mr. Bernanke cannot draw on a boundless reservoir of good will. As the economy recovers, responding quickly and fully to inflation threats may prove hard in the face of public opposition.”

There it is… Mankiw literally wrote the textbook on economics (mine at least), and even he sees little chance of Bernanke standing up to inflation. And now, a fourth reason. Why fight inflation when it’s one of a debtor nation’s best friends? In the face of a sovereign debt crisis it’s much more palatable, an in that sense considerate, than cold austerity or harsh default.

See The New York Times for his article on Bernanke and the inflationary beast.