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Is Inflation Coming? May 30, 2009

Posted by hslu in Economics.
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Is Inflation coming?

Mr. Paul krugman published an Op-ed on NY Times on May 28, 2009 arguing that the Big Inflation Scare is not founded.

He reasons that banks are not lending and, in some cases, even return the money back to the Fed. He also suggests that Japan, facing similar difficulties in late 1990’s and early 2000’s purchased a tremendous amount of debt. But the consumer prices there fell instead!

I am not sure this is a legitimate comparison though. Japan is facing two very serious  problems: aging population and low birth rate which I believe are the primary reason, among others, responsible for falling consumer prices. Government spending has limited effect because Japanese, especially older Japanese, are savers instead of spenders. We know that savers do not grow economy. Spenders, such as American, do!

Japan’s economy is heavily dependent on export which has been under serious competition from countries such as China. As a result, its economy has not been able to grow like it did in the 1980’s. As economy stagnant or slowed down, consumer prices fell despite heavy government spending.

The economy of the United States is consumer-driven which accounts for roughly 70% of the GDP. Americans are accustomed to spending and, as a nation, our savings rate has been hovering around 0% for many years. The financial crisis has changed our spending habit and has raised our savings rate to about 4% in recent months. The reduction on consumer spending and tight lending practices have been largely responsible for the contraction of GDP since December 2007. Despite government spending which is inherently inefficient and wasteful, the recession will not end until housing market recovers, bank lending returns to normal and job market stabilizes. Government spending by itself will not end the recession, period.

In other words, credit will eventually start to flow to corporations and consumers. Otherwise the economy will not grow very fast. Without growth, the recession will not end. Lending will come back because banks will not sit on their reserves forever and investors will demand a better return. The consumer will return to spending once stock market recovers and housing market bottoming out. As we feel better for our future and our jobs, savings rate will decline again and consumer spending will pick up.

When that happens, the extra money supply that the Fed has been putting in the system will eventually lead to inflation. All we need now is time.

We will see in 2 years whether Mr. Krugman is right or wrong.

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