Legal Commentary

Greg Mankiw on Inflation and the ?Surging Monetary Base?

By Kenneth Anderson

Over at Greg Mankiw?s blog, a discussion of whether the ?surging monetary base? necessarily means inflation down the road:

Both reserves and T-bills are interest-paying obligations of the Federal government (including the Federal Reserve).  They are essentially perfect substitutes.  The monetary base, however, includes one of them but not the other, largely for historical reasons.

The bottom line is that when reserves pay interest, the monetary base is a pretty uninteresting economic statistic.

Does this mean that investors should stop worrying about inflation?  No.  Yet the worry should stem not from the monetary base but from the political economy and difficult tradeoffs facing monetary policymakers.  As the economy recovers, interest rates will likely need to rise.  Will the Bernanke Fed, feeling the political heat, get behind the curve and allow inflation to take off?  Will it decide that a little bit of inflation is not so bad compared with the alternative of risking an anemic recovery, a double dip recession, or (gasp!) congressional action to reduce Fed independence?   Maybe.  This is, I think, the right way to argue that higher future inflation is a plausible outcome.

I don?t know whether such inflation worries are justified.  But I am pretty sure that the exploding monetary base is not, by itself, a reason to fear a coming surge in inflation.

Mankiw remarks on a WSJ article a few days ago talking about some large investors betting on a rise in inflation and citing the the rise in the monetary base.  My own view is that these investors are perfectly aware of this, but are, in fact, making a political macro-bet that policy-makers will not have the political will to restrain inflation.  It would not surprise me in the least if it were the bet Soros ultimately makes ? many, perhaps even most, of his biggest plays over the years have come by making political bets on the failure of immediate political will, starting with his bet twenty years ago against the pound.

Let me ask our readers a lightly different question.  How good are inflation-indexed USG debt as a hedge against inflation?  A prominent commentator ? Martin Feldstein, I believe ? suggested a few days ago that for many retail investors, they were a much better inflation hedge than gold.  (Someone might be good enough to send me the link.)  What is your view, both on the inflation outlook and on inflation hedges for the retail investor?

Full post as published by The Volokh Conspiracy on December 29, 2009 (boomark / email).