Allan Meltzer has an excellent article in the NYT today about the possibility of inflation. It isn’t here yet but given the underlying conditions of high money supply (and low interest rates) and high budget deficits, inflation may come much faster than the FED is able and willing to respond effectively.

On the same day Paul Krugman warns in the NYT about the problems of wage deflation. He points out that Japan faced the same problem in the 1990s and suffered more than a decade of stagnation. His solution is greater fiscal expansion … which clearly will raise budget deficits and raise the threat of inflation that Meltzer warns about.

Unfortunately Krugman’s argument makes inflation an even greater possibility. That’s because calls for more fiscal expansion by prominent economists will make it more likely that the FED response to inflation will be too slow in coming. Remember that FED response to inflation takes time. Ideally the FED should act many months before the inflation is even apparent. But this almost surely won’t happen. The FED will more likely wait until it becomes obvious that inflation has reignited and and that time the only way to prevent overheating of the economy on the upswing would be to recreate a 1981 style recession.

Thus, I think the possibility of a double-dip recession is rising.

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