Page 89 - Accelerating out of the Great Recession

ACCELERATING OUT OF THE GREAT RECESSION

The unprecedented levels of new government debt and the
aggressive lending by the central banks have—until now—pre-
vented this from happening. But the first implications of the
deleveraging activity are visible.
In normal times, the unconventional stimulus measures taken
by governments and central banks over the past year would have
been highly inflationary. An increase in the balance sheet of a cen-
tral bank typically would lead to higher credit growth—and infla-
tion—if supply does not pick up. Milton Friedman, the econo-
mist, described this as “too much money chasing too few goods.”
In the aftermath of the Great Recession, though, the so-
called money-multiplier process has collapsed. As a result, an
increase in the supply of money from central banks has not led
to more credit—and therefore inflation. It has merely helped to
stabilize the existing volume of credit in the economy.
The trouble is that the global economy—and, particularly,
highly leveraged economies such as the United States—needs
inflation in order to facilitate the efforts of companies and con-
sumers to reduce their debt levels. Some observers argue that
once national economies return to a stable growth path, central
banks and governments will have little reason to prevent or con-
trol inflation.
What is certain is that the task of reversing their aggressive
monetary stimulus policies will be difficult. As the Federal
Reserve Bank of Dallas noted in a working paper, “As the real
economy improves, tightening must be ‘measured’ enough not to
destabilize still fragile confidence and financial markets but also
fast enough not to allow inflationary expectations to rise too
much. This will be particularly difficult if the source of demand
expansion was itself a rise of inflationary expectations associated
with quantitative easing. And to all this must be added the risk

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