The return of the Jedi

In Lucas' (George, not Robert) brilliant Star Wars saga, the dark side of the Force had finally been beaten. The evil converted to the better faith for good.

Incidentally, around the same time this saga started its lasting success, Paul Volcker became chairman of the Federal Reserve. He successfully started to fight inflation (after others made a couple of half-hearted attempts). It was very costly, and - more importantly - it could had been avoided by Volcker's predecessors if they only had considered the long-term consequences of what they were doing in their attempts to prevented the public from seemingly wrong decisions (just like Anakin Skywalker, called Darth Vader, did).

Allan H. Meltzer, a distinguished Monetary Historian, writes in a NYT piece that this lesson has not been well learned by U.S. policy makers and hence, in contrast to the Star Wars saga, the evil is not beaten for good. He claims that economic policy, both fiscal and monetary, are heavily inflationary and that the cost of this policy will come, sooner or later.

[...] no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.

He incuses policy makers, both at the Fed and Congress, to sacrifice the independence of the FED which simply has become the monetary arm of the treasury. It is the same independence that Paul Volcker had to fight for, and which was necessary to achieve the goal of lowering inflation rates.

Meltzer also argues that deflation is certainly not the problem, even though headline consumer price inflation approaches zero:

Some of my fellow economists, including many at the Fed, say that the big monetary goal is to avoid deflation. They point to the less than 1 percent decline in the consumer price index for the year ending in March as evidence that deflation is a threat. But this statistic is misleading: unstable food and energy prices may lower the price index for a few months, but deflation (or inflation) refers to the sustained rate of change of prices, not the price level. We should look instead at a less volatile price index, the gross domestic product deflator. In this year’s first quarter, it rose 2.9 percent — a sure sign of inflation.

Finally, Meltzer is not a friend of deficit-financed government programs.

It doesn’t help that the administration’s stimulus program is an obstacle to sound policy. It will create jobs at the cost of an enormous increase in the government debt that has to be financed. And it does very little to increase productivity, which is the main engine of economic growth.

His argument goes further:

[...] big, heavily subsidized programs are rarely good for productivity. Better health care adds to the public’s sense of well-being, but it adds only a little to productivity. Subsidizing cleaner energy projects can produce jobs, but it doesn’t add much to national productivity. Meanwhile, higher carbon tax rates increase production costs and prices but do not increase productivity. All these actions can slow productive investment and the economy’s underlying growth rate, which, in turn, increases the inflation rate.

In this respect, Meltzer hopefully errs.