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Keynes Or Friedman? Bernanke Chooses Keynes…For Now

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A new article from Bloomberg spells out the possible scenarios we face. Obviously I side much more with the Keynes approach because of the reasons laid out here, but obviously inflation fears aren’t unfounded.

Here’s more…

Federal Reserve Chairman Ben S. Bernanke is siding with John Maynard Keynes against Milton Friedman by flooding the financial system with money.

If history is any guide, says Allan Meltzer, the effort will end in tears. Inflation “will get higher than it was in the 1970s,” says Meltzer, the Fed historian and professor of political economy at Carnegie Mellon University in Pittsburgh. At the end of that decade, consumer prices rose at a year-over- year rate of 13.3 percent.

Bernanke’s gamble that the highest jobless rate in 25 years and the most idle factory capacity on record will hold down inflation is straight out of the late British economist Keynes. Should late Nobel-prize-winner Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon” prove right, the $1 trillion or more in liquidity Bernanke has pumped into the financial system by expanding the Fed’s balance sheet may leave him to cope with surging consumer prices.

So how’s the strategy working out so far? Too early to tell, but still…

So far, investors and economic data both back up the Bernanke-Keynes view. The market in Treasury Inflation-Protected Securities as of April 6 indicated long-term inflation expectations of 2.5 percent, below the 2.8 percent average inflation rate of the past 10 years.

Figures to be published April 15 will probably show that the March consumer price index was unchanged from a year earlier, thanks to a steep decline in energy costs, according to economists surveyed by Bloomberg News. In February, the index rose at a year-over-year rate of just 0.2 percent.”

As many of us on the “bailout/stimulus” side have conceded, it’s not sustainable for government to be the engine that drives the economy. So none of us are suggesting that we switch from market driven economics.

But in those rare, once-in-a-generation instances where nobody is spending and you’re facing a deflationary spiral scenario, they can step in an prime the pump. Whether that’s right or wrong remains to be seen, but no doubt we’ll be debating this for years to come.