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Economics: The Economics of Being Wrong

November 28, 2011

Earlier I posted a chart from Federal Reserve’s research site showing (non) relationship between monetary base and inflation. Afterwards I happened to come across a Wall Street Journal piece by Arthur Laffer: Get Ready for Inflation and Higher Interest Rates.

With the crisis, the ill-conceived government reactions, and the ensuing economic downturn, the unfunded liabilities of federal programs — such as Social Security, civil-service and military pensions, the Pension Benefit Guarantee Corporation, Medicare and Medicaid — are over the $100 trillion mark. With U.S. GDP and federal tax receipts at about $14 trillion and $2.4 trillion respectively, such a debt all but guarantees higher interest rates, massive tax increases, and partial default on government promises.

But as bad as the fiscal picture is, panic-driven monetary policies portend to have even more dire consequences. We can expect rapidly rising prices and much, much higher interest rates over the next four or five years, and a concomitant deleterious impact on output and employment not unlike the late 1970s.

Since then, the Fed’s added another $1 trillion+ in monetary base.

Yet still no inflation.

It’s rare for economic conditions to clearly and unambiguously test economic theories. But this is one of those times.

What are the consequences – if any – when a theory is wrong?

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