Bernanke and the Beast

By N. GREGORY MANKIW
Published: January 16, 2010

http://www.nytimes.com/2010/01/17/business/economy/17view.html

In this article, Mankiw believes, based on the condition of American economy, if not cautious, it is possible to trigger hyperinflation.


First, in order to explain his viewpoints, he briefly introduces two basic principles of Economics; one is that “prices rise when the government creates an excessive amount of money. In other words, inflation occurs when too much money is chasing too few goods”(Mankiw lines5-9) , and another is “governments resort to rapid monetary growth because they face fiscal problems. When government spending exceeds tax collection, policy makers sometimes turn to their central banks, which essentially print money to cover the budget shortfall”(Mankiw lines10-14) Then, Mankiw points out there is already existing two classic ingredients for high inflation of American Economy, including large budget deficits, which was $390 billion in the first quarter of fiscal 2010, and ample money growth that the monetary base(currency plus bank reserves) has more than doubled over the last two years. Further, he says banks have been pleased to hold much of new money as excess reserves. Yet, it is not the normal time when the Fed expands the monetary base, banks lend out that money, and other money-supply measures grow in parallel. Mankiew explains, in this special phase, most banks prefer to have more idle cash that the broad measure called M2，which contains currency and deposits in checking and saving accounts , has only grown 6 percent during the last two years at an annual rate. Then he predicts, it might be worse as the economy recovers, since banks may start lending money, which could lead to faster growth in M2, and, eventually, to substantial inflation.


On the other hand, Mankiw admits that the Fed has tools to prevent the possible inflation, either selling large portfolio of mortgage-backed securities and other assets or, on the basis of modified legislation, paying interest on reserves; When economy recovers and interest rates rise, the Fed can increase the interest rate it pays banks, attracting banks to keep reserves at a certain level, and, therefore, prevent the huge expansion in the M2 from becoming inflation.


Nonetheless, Mankiw casts his doubt on whether the Fed would make enough use of these instruments when needed. First, he points it is hard to keep inflation in an appropriate degree, which helps the economy recover without losing control of the process. Moreover, it is easily overestimate the economy’s potential growth. And if the fed ends up raising taxes in a wrong time, too early to ends it up, it could also cause a high inflation. Finally, politics could constrain the Fed’s policy choices; it would be hard to get support if simply raising interest rates, which is against people’s wish, to cope with impending inflationary pressures.


At the end of this article, Mankiw concludes that, after all, it is hard for anyone to be sure what is the optimal method to solve the problem existed now.