Masking the Real Estate Bust Using Inflation

The American Enterprise Institute in an editorial in yesterday's Wall Street Journal calls for expanding the money supply and ignoring the resulting inflation: The Inflation Solution to the Housing Mess

The least bad option is for the Federal Reserve to print money to help stabilize housing prices and financial markets. Yes, use reflation to soften the pain for Main Street and Wall Street. If instead we let housing prices fall another 25%-30% – as predicted by the Case-Shiller Home Price Index – it's almost certain that Washington will end up nationalizing the mortgage business.

I predicted over a year ago (unfortunately before this blog's existence) that this would happen. Lowering rates without regard to inflation has already been the Fed's policy since the housing bust started in earnest.

It's surprising to hear calls for loose monetary policy from a rightwing source. The article says they would rather accept inflation now, though, than deal with excessive action from Congress, which would be harder to undo than a monetary policy decision.

The Fed will allow inflation to happen, not because of rightwing fear of regulation, but because there are quite a few highly leveraged homedebtors who stand to benefit.

The article doesn't mention two other repercussions from the higher nominal interest rates that come with inflation:

• There will be increased pressure to balance the federal budget.
• Higher mortgage rates will intensify that effect of falling inflation-adjusted real estate prices.

These things aren't horrible. They're side effects of over-medication of the economy. This over-medication is a response to living on the economic edge, i.e. excessive risk taking and insufficient savings.

The right thing is for the Fed and Congress to act moderately. The economy is a problem primarily for people who took big risks. Risk takers getting hurt once in a while is supposed to be part of an economic system.