Preventing Deflation Should Be The Fed's Top Priority

A high percentage of my recent posts (scratch that; I have no recent posts – say a high percentage of my posts since the summer) have been devoted to voicing my skepticism that looser monetary policy can engineer a meaningful recovery. My own view is that what you’d get instead is new speculative bubbles and a new crisis.

But that doesn’t mean monetary policy should err on the side of tightness in all circumstances. And if we’re at a real risk of slipping into a new round of deflation we should be erring very heavily on the side of looser money. That’s particularly true because the situation with the Euro is sufficiently touchy that we could experience a sudden and substantial liquidity shock with very little warning.

Inflation is dangerous. Deflation is much more dangerous. The Fed should be signalling very clearly that they have the tools available to prevent deflation, that they are ready to use them, and that preventing deflation is their top priority, even if it means overshooting on in an inflationary direction.

So for the time being, the inflationists and I are on the same side. Hopefully, clear messaging and prompt action on the Fed’s part will do the trick, and in a quarter or two we can go back to arguing about how to generate a real, sustainable recovery.