Monday, December 27, 2004

Gems from W. Arthur Lewis, part 2

"In any society that uses money, whether it be capitalist or socialist, there will be inflation if the sums being spent on producing investment goods exceed the sums that people are willing to save, unless the difference is either lent by foreigners or absorbed by a budget surplus. This is because there will be inflation if the sums spent by the public on buying consumer goods exceed the sums spent on producing producer goods. It is in this framework that we must see and compare the policies of such ountries as the U.S.A., Germany, Japan, and the U.S.S.R in the 1930's."

This quote gets at an idea that many people seem to be neglecting when they think about the US current account deficit. Consumer spending at the moment is financed by foreigners (as Brad Setser explains so well), and when they get tired of doing so, the result will be just like a huge supply shock. Suddenly, goods that were previously available at a very cheap price thanks to borrowed money will become more expensive. The only way to control this inflationary pressure is for the Fed to tighten monetary policy.


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