Memories Of Scare Tactics Past: [T]he spring of 2009 was also the period of the great inflation scare, in which everyone from Glenn Beck to Federal Reserve presidents was warning us that an awful surge in prices was just around the corner. Funny how that didn’t happen. Now, everyone makes wrong predictions. But this particular failure goes deeper than just not seeing what was coming. At the heart of the inflation/deflation debate was and is a debate between two visions of the economy.
One vision, which is the one I subscribe to, is basically an updated Keynesian view: sticky prices revised gradually based on unemployment and excess capacity, the possibility of persistent economic malfunction because people are trying to hoard cash rather than buying real goods. And this view also said that we were and are in a liquidity trap, in which things that might have been inflationary under other conditions — like a large expansion of the monetary base — weren’t at all inflationary under current conditions. In fact, the likely outlook was for falling inflation, and possibly deflation.
The other vision was basically a crude quantity theory of money view: hey, the Fed is printing money, the government is running deficits, so high inflation, maybe even hyperinflation, is staring us in the face.
The past year has, in effect, been a fairly clean test of these two views. And what has happened has been very much what people like me said would happen: in the face of persistent high unemployment, inflation has fallen despite all that money creation, and interest rates have stayed low despite those budget deficits. If you bet on inflation and rising rates — which, by the way, Eric Cantor, the Republican House whip, did — you lost a lot of money.