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"high inflation would reduce the real level of debt, allowing indebted households and banks
to deleverage faster and with less pain"
What I hear more and more, both from bankers and from economists, is that the only way to end our financial crisis is through inflation.
Their argument is that high inflation would reduce the real level of debt, allowing indebted households and banks to deleverage faster and with less pain.
The advocates of such a strategy are not marginal and cranky academics. They include some of the most influential US economists.
Wolfgang Münchau, Financial Times, May 24 2009
To achieve the desired increase in inflation, the US Federal Reserve should either announce an inflation target or simply keep interest rates at zero when the recovery begins. That way, real interest rates would become strongly negative.
A policy to raise inflation could, if successful, trigger serious problems in the bond markets.
Inflation is a transfer of wealth from creditors to debtors essentially from China to the US.
A rise in US inflation could easily lead to a pull-out of global investors from US bond markets.
This would almost certainly trigger a crash in the dollars real effective exchange rate, which in turn would add further inflationary pressure.
The central bank would eventually have to raise nominal rates aggressively to bring back stability. It would end up with the very opposite of what the advocates of a high inflation policy hope for. Real interest rates would not be significantly negative, but extremely positive.
We have two options. The first is to deflate debt, the other is to inflate assets
The core of the problem, the unavoidable truth, is that our economic system is laden with debt,
about triple the amount relative to gross domestic product that we had in the 1980s.
Nassim Nicholas Taleb and Mark Spitznagel, FT July 13 2009