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Just a thread I'd like to get started where I dump everything I've learned about the inflation/deflation debate in one place in crisp summarized statements.
- demand shocks, mainly caused by excess unproductive credit growth that is not sustained (since unproductive debt growth is obviously unsustainable), send the economy into an output gap, diminish credit growth and deflate asset prices and the CPI
- it is a matter of time before the monetary authorities stimulate the economy back to full output; the free market also has means of restoring full output but under the modern set-up, these means are obstructed from running their course by laws, welfare provisions and the fact that the economy expects the authorities to act; i.e. it is addicted to stimulus and as a result needs the stimulus to recover
- the longer an output gap drags on, the more damage is done to potential output through hysteresis and capital flight; this is the main conduit via which a deflationary situation turns into an inflationary one; stimulus will at a certain point restore full output but the question is, WHERE IS full output at that point; if there has been a long standing output gap, it most likely is NOT at the pre-crisis trend level
- the government can not reduce its spending during the output gap lest the deflationary forces are reinforced; this means that government spending remains more or less stable as a proportion to pre-crisis trend output growth; here in lies the problem: the economy does not recover to the trend rate, but government spending goes on as if it will
- when the stimulus gets the economy out of its output gap, NAIRU (the level of unemployment at which inflation starts to get out of control) is reached sooner than anyone expects and suddenly it becomes clear that government spending is structurally too high; by this time however, it is too late to cut back on it; inflation is the only escape
- inflation engineering is always worse than people expect because smart investors flee out of fixed income denominated in the currency in question before it happens; they price in inflation premiums; hence, the rent-extraction that inflation engineering constitutes leeches off the "dumb money" only; if there is, say, only half as much capital to leech from, twice as much inflation engineering has to be engaged in to get the same results; this is one reason why inflation easily spirals out of control
- another reason why inflation is impossible to contain once it's left out of the bottle is because the taboo on breaking monetary targets is broken; if the central bank brazenly disregarded and violated its inflation promises before, why do you trust it when it makes a new promise?
- another issue: from Steve Keen's work we know that if the central bank only stabilizes the CPI and does not induce debt-to-GDP growth in the private sector, asset prices have to fall since they were being propped up by credit driven demand. This destroys the banking system and prompts the central bank and government to act through measures such as TARP. In the long run, inflation has to be sent above it's regular target to protect nominal asset prices. This is another explanation as to why inflation is inevitable under the current set of systems and rules.
- I expect that at a certain point, a TARP will be engaged in that the government KNOWS can only be funded by debt monetization. Let's call it the Weimar TARP. Or was TARP1 already a Weimar TARP?
- demand shocks, mainly caused by excess unproductive credit growth that is not sustained (since unproductive debt growth is obviously unsustainable), send the economy into an output gap, diminish credit growth and deflate asset prices and the CPI
- it is a matter of time before the monetary authorities stimulate the economy back to full output; the free market also has means of restoring full output but under the modern set-up, these means are obstructed from running their course by laws, welfare provisions and the fact that the economy expects the authorities to act; i.e. it is addicted to stimulus and as a result needs the stimulus to recover
- the longer an output gap drags on, the more damage is done to potential output through hysteresis and capital flight; this is the main conduit via which a deflationary situation turns into an inflationary one; stimulus will at a certain point restore full output but the question is, WHERE IS full output at that point; if there has been a long standing output gap, it most likely is NOT at the pre-crisis trend level
- the government can not reduce its spending during the output gap lest the deflationary forces are reinforced; this means that government spending remains more or less stable as a proportion to pre-crisis trend output growth; here in lies the problem: the economy does not recover to the trend rate, but government spending goes on as if it will
- when the stimulus gets the economy out of its output gap, NAIRU (the level of unemployment at which inflation starts to get out of control) is reached sooner than anyone expects and suddenly it becomes clear that government spending is structurally too high; by this time however, it is too late to cut back on it; inflation is the only escape
- inflation engineering is always worse than people expect because smart investors flee out of fixed income denominated in the currency in question before it happens; they price in inflation premiums; hence, the rent-extraction that inflation engineering constitutes leeches off the "dumb money" only; if there is, say, only half as much capital to leech from, twice as much inflation engineering has to be engaged in to get the same results; this is one reason why inflation easily spirals out of control
- another reason why inflation is impossible to contain once it's left out of the bottle is because the taboo on breaking monetary targets is broken; if the central bank brazenly disregarded and violated its inflation promises before, why do you trust it when it makes a new promise?
- another issue: from Steve Keen's work we know that if the central bank only stabilizes the CPI and does not induce debt-to-GDP growth in the private sector, asset prices have to fall since they were being propped up by credit driven demand. This destroys the banking system and prompts the central bank and government to act through measures such as TARP. In the long run, inflation has to be sent above it's regular target to protect nominal asset prices. This is another explanation as to why inflation is inevitable under the current set of systems and rules.
- I expect that at a certain point, a TARP will be engaged in that the government KNOWS can only be funded by debt monetization. Let's call it the Weimar TARP. Or was TARP1 already a Weimar TARP?
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