When it comes, I don’t expect the fast flip to inflation or hyperinflation that many fear, but rather a gradual increase. My reasoning for this is I agree with Keen that the money multiplier theory is misleading and we won’t suddenly regain confidence and magically restore a historically traditional multiplier to base money in a short period of time… it will take years for people to want to borrow again in sufficient quantity to spur growing inflation and to be credit-worthy enough to do so. And any fear-of-inflation-driven flight to hard assets likely won’t feed through into wage inflation with huge current global labor and manufacturing overcapacity, so I would expect it to be self-limiting as it further chokes off spending power (higher commodity prices).

Of course there are always some wildcards that could change everything… global wars, dramatic accelerations in global climate change, currently unimaginable political actions such as printing tens of trillions of dollars in a short time targeted to those most likely to spend (i.e., not banks), etc. Governments we are used to tend to limit themselves at least a little due to political constraints (witness the democrat/republican standoffs so far in 2009) but as Keen and others point out, dramatically new governments have come to power in economic crises in history. Not to dwell on the gloomy though — I hope these are all low probability outcomes.

Ed, what do you mean by “few precedents”? There have been credit booms and busts throughout history (with The Great Depression and Japan 1990 as two good examples). The biggest difference this time IMO is the terrifying magnitude of the global debt bubble (measured by debt-to-GDP ratios, etc).

Also, what do you mean by “get things to work” and “if the economy does turn”. Turn how? Back to expanding lending?

No matter whether we get inflation or deflation (and I think the former unlikely), growth in debt has contributed substantially to GDP over the last decade or two, so in a scenario of either debt reduction or debt stagnation at current debt levels, real GDP must fall. So to echo Galbraith, I don’t see how there can be any return to “normal” in the next decade at least.

http://www.creditwritedowns.com/2009/03/don%e2%80%99t-underestimate-the-power-of-printing-money.html#comment-4467

The long and short of my thinking is this: no one knows what will happen because these are historic times with few precedents. However, it is clear that the Fed is being very aggressive with its money printing campaign. So, they just may get things to work. In November-December, I tended to think deflationary forces were too large to overcome, but the Fed has really gone to town here. In my view, if the economy does turn, inflation will be a huge problem – so massive is the stimulus and so massive is the deterioration in the Fed’s balance sheet. Of course, this is just my opinion because no one really knows what is going to happen here.

Anyway, hopefully Ed might chip-in here, but meanwhile I found this article interesting:

http://www.washingtonmonthly.com/features/2009/0903.galbraith.html

where he says among other things “A brief reflection on this history and present circumstances drives a plain conclusion: the full restoration of private credit will take a long time. It will follow, not precede, the restoration of sound private household finances. There is no way the project of resurrecting the economy by stuffing the banks with cash will work. Effective policy can only work the other way around.” which seems to tie-in well with Ed’s question?

Stevie b. – Personally the answer I’m most confident in is that offered by economist Steve Keen. He doesn’t believe printing will solve this crisis, but nor does he believe that printing will be big enough to cause inflation in at least the next few years. If you (or Ed) disagree with him I’ve love to hear why.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5006888/Friedman-and-Schwartz-should-be-compulsory-reading-as-we-try-to-fix-the-banks.html

but he doesn’t even talk about the possibility of eventual meaningful inflation…which is some omission from a monetarist, unless of course he thinks there wont be any meaningful inflation..?

today I am just shocked out how the Fed has chosen to handle all this.

http://www.creditwritedowns.com/2009/03/don%e2%80%99t-underestimate-the-power-of-printing-money.html

It seems reckless. Mortgage rates are coming down, as are treasury yields but printing money and easing credit cannot possibly solve this, can it?

These are seriously troubled times.