Strangled by Tight Money

Inflation-phobes resemble someone stranded in the desert without water who spends his time frantically searching for a life preserver.

Remember the guy who ran for governor of New York as the candidate of the Rent Is Too Damn High Party? We need a new one, called the Money Is Too Damn Tight Party. It would get my vote.

But the vote it needs belongs to Federal Reserve Chairman Ben Bernanke, and he isn't giving it. On Wednesday, the Fed indicated it would stick to its current course, declining to embark on another "quantitative easing" that would inject a lot more money into the economy.

He and many other people have awful memories of high inflation from the late 1970s and early 1980s. No one wants to repeat that experience. But inflation-phobes resemble someone stranded in the desert without water who spends his time frantically searching for a life preserver.

Plenty of people, including several Republicans who ran for president, think money is too loose. But what would the world look like if the opposite were true?

Commodity prices would fall. Unemployment would be painfully high. People would be reluctant to buy houses for fear they would lose value. Economic growth would stall.

Sound familiar? Those signs are a tipoff to our real economic problem: too few dollars in circulation.

The U.S. economy is not experiencing actual deflation. But a person who has a cold doesn't take great comfort in not having pneumonia. Right now, the economy is showing signs of a malady that looks like deflation's close relative.

Inflation occurs when there is too much money chasing too few goods. Deflation occurs when there is not enough money. For years, inflation alarmists have been forecasting runaway prices as a result of the Fed's efforts to expand the money supply. But prices have remained stable, with the Consumer Price Index down last month and up just 1.7 percent in the past year.

Don't believe the official numbers? The Billion Prices Project at MIT says lately, inflation is actually lower than the government estimates.

By now, it should be obvious that the problem is not that the Fed has injected too much money into the economy but too little. The price of gold—which jumps at the slightest whiff of inflation—has plunged from more than $1,900 an ounce last year to less than $1,630.

The commodity price index is down 7 percent from a year ago. Home sales have been tepid despite mortgage rates lower than anyone could ever have dreamed.

When lenders anticipate debasement of the currency, they demand higher interest rates to compensate for the risk. But currently, five-year Treasury bills are paying 0.71 percent, and 20-year bonds offer only 2.33 percent. In the mid-90s, a period of low inflation, those rates ranged well north of 5 percent.

Inflation hawks have been predicting a severe outbreak for years. But David Henderson, an economist at Stanford University's Hoover Institution and the Naval Postgraduate School, has been skeptical enough to put his money where his mouth is.

In December 2009, he publicly bet economist Robert Murphy of the Pacific Research Institute $500 that by January 2013, there would not be a single point at which the CPI would be up 10 percent or more from a year before. So far, it hasn't been, and it shows no sign it will.

Another economist who thinks inflation is the least of our worries is Scott Sumner of Bentley University in Massachusetts. He says the increase in the money supply has not unleashed inflation because the demand for dollars has risen as well.

When banks or individuals hold on to cash, he notes, the effect is the same as if the Fed were shrinking the money supply. By refusing to spend or invest, they stifle economic activity.

That effect is apparent in the slowing of the economy, which was not exactly galloping to start with. That has put job growth on a glacial pace. Three years after the recession officially ended, we have five million fewer jobs than we had before it began.

The Fed's past quantitative easing programs have helped, but they haven't been big enough or lasted long enough. Sumner argues the central bank should commit to sticking with that tactic as long as it takes to get growth back to a healthy pace—backing off only if inflation gains a real foothold.

Could inflation make a comeback? Sure. So could the Soviet Union. But until it does, we should deal with dangers that are not imaginary.

Steve Chapman blogs daily at newsblogs.chicagotribune.com/steve_chapman.