May 26, 2018

Efforts to Spur Growth Can Backfire

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Efforts to Spur Growth Can Backfire

Deflation is the problem today but if the Federal reserve isn't careful, inflation could be the problem tomorrow.

In March, the consumer price index posted its first 12-month decline since the Eisenhower administration. The Federal Reserve has thus rightly focused on getting the economy moving by taking unprecedented steps to ease the credit crisis. To do nothing is to risk a paralyzing economic stagnation in which households delay purchase decisions in the expectation of future price declines.

Yet the Federal Reserve’s solution could spark an equally troubling problem. To spur growth, the Fed has expanded its balance sheet to more than $2 trillion. That infusion of money will almost certainly stimulate the economy but, if the pump stays open for too long, the result will be upward pressure on prices. Everything from hamburgers to airfare will rise and we could be in for an inflationary spiral.

If there is inflation, property owners would be clear winners, as the value of real tangible assets like real estate will rise. That’s why property values rose in tandem with consumer price inflation in the 1970s and early 1980s.

But buyers will lose. High inflation automatically brings high interest rates. Lenders will charge a higher rate to compensate for the loss in purchasing power. Nobody wins if households can’t afford the cost of money to buy.

To be sure, inflation isn’t inevitable. The Fed might be able to move quickly to mop up its cash infusion. But some of the money the Fed has pumped into the economy is long-term debt that can’t be mopped up so quickly. That leaves a distinct possibility of inflation picking up, hurting growth.

The economy can’t operate optimally in an inflationary environment because of the uncertainty it creates, particularly for business start-ups. For that reason it’s imperative that the Fed keep its eyes on inflation, just as it has on deflation.

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