After I published a piece in the New York Times op-ed page warning of future inflation (see: “Inflation Nation“), Paul Krugman claimed to offer me a “history lesson” on his Times blog (see his post: “A History Lesson for Alan [sic] Meltzer“).
In the piece I argued that no country with rapid money growth, a large budget deficit, and an expected depreciation of the exchange rate has ever experienced deflation, always inflation. He claims Japan’s “lost decade” as a counterexample. It is not. I am very familiar with Japan during this period—I served as honorary adviser to the Bank of Japan and met often with the then Governor Hayami. He opposed using monetary expansion, and I did not convince him that he was making a mistake. In the midst of the deflation, he raised the interest rate to avoid “sloppy” money markets. That was the wrong thing to do as several of us told the Bank of Japan at the time.
When Governor Fukui replaced Governor Hayami, he carried out the policy that I had urged Governor Hayami to follow. He bought long-term bonds.
The deflation ended, contrary to the advice of Professor Krugman, who claimed at the time that monetary policy was in a “liquidity trap” and useless. He was wrong then and he neglects that, unlike the United States today, Japan financed its excess spending from domestic saving. We have to borrow from others. The Chinese have sent several signals warning that they may be reluctant to finance our outrageously large deficits.
On the op-ed page in the Times on which we both appeared, Professor Krugman repeats the same message he writes regularly. We differ about the degree to which the Federal Reserve and the administration should concentrate solely on the near-term problems of the economy instead of considering the medium- and longer-term effects of their current actions. Tomorrow comes and a well run central bank neither ignores today’s problems nor neglects tomorrow’s. Wages are not falling, no matter how many times Professor Krugman reminds us that they might. To avoid the inflation that it is creating, the Federal Reserve should be less expansive.