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Last week’s farce with the GDP numbers certainly played into the hands of the Austrian School, who say that economists should rather use their heads than statistics. Furthermore, we should recognize that Ben Bernanke and his helicopter fly through the dark of a Great Recession with the lights off, because his DSGE models don’t know what banks are or what ‘insolvency’ means. In normal times, these models work fine, but now…
Many people think that, under these difficult circumstances, Ben prefers to err on the his safe side and let inflation run too high. But, suprisingly, there are others wo see him choose deflation.
The fact that Bernanke chose to keep his hands off the QE 2.0 button until now, although another recession looms in the coming months, supports this theory. The article from Political Calculations says that Bernanke may revert to inflation in the long-run. I’m not so sure about that. Inflation as a way to reduce government debt worked in the 1970s, but that was a totally different time.
There were regulatory restrictions on capital movements and most US debt was bought and held by US residents. Now we have free capital flows across the globe and most newly issued US debt is bought by foreigners. They would surely demand higher risk premia as a compensation for increased risk of devaluation of the US dollar. I suppose US residents will not be so picky since there is this thing called “investors’ home bias”.
So I think that Bernanke has to keep inflation low, if he really wants to help the Treasury in selling that huge pile of stinking debt.