James Surowiecki has a commentary in the September 14 issue of the New Yorker arguing that some are over-reacting to the prospect of inflation and that we should "wait until the car is actually moving forward before we worry about applying the brakes." The problem with this statement is that Surowiecki ignores the role of expectations in economic theory.
I've noted before that expectations can be more important to economic and financial market performance than actual results. This white paper from the IMF highlights the role of expectations very well. Economic participants will adjust their current behavior to meet their expectations of future results. Many worried about inflation are worried because they expect that government spending, in the form of the fiscal stimulus, will not be curtailed in the near future when "the car" is moving. Consumers and businesses cut back on spending for a variety of reasons - lack of employment, self-preservation, and expectations of future needs for current income such as higher taxes. The current increase in government spending offsets that decline in private spending. Once the car is moving, however, it becomes difficult to "apply the brakes". The paper notes that private spending will increase if expectations are that public spending will fall in the future. That does not appear to be the case in the current environment. Instead, many among the private sector are not expecting public spending to decline. That expectation, in turn, leads to the expectation of inflation.
Because of the lag in monetary and fiscal policy, "applying the brakes" after the "car is moving" will be too late to prevent inflation. As I see it, economic participants are expecting inflation because they don't expect government spending to fall when private sector spending increases (GDP growth turns positive again). Higher public spending + higher private spending + increased money supply + low interest rates = very high probability of inflation. Hedging inflation expectations makes sense - if I'm wrong, the hedge can be unwound. If I'm right, my portfolio will hold up better than most - especially of those waiting to apply the brakes after the car gets moving.
