Inflation

Question (s),
From what I understand inflation is a monetary phenomenon. Meaning the gov't lowers interest rates by buying t-bills or other financial instruments which increases the money supply? Also, they buy the t-bills with printed money, always or if we ever had a surplus they could use that?
This will be a multi part question and answer for whoever wants to get involved, thank you.

What is the forward market indicating? Whether we we should worry about under 2% inflation can be seen from the TIPS spread, not from the CPI of the past.

TIPS Spread? Do you mean between the 5 yr and 20 yr or other bonds like 3 month t-bills?

It seems a lot of the deflation talk I'm hearing has to do with people simply looking back to the 30s, and trying to predict events now based on that.

The 30s happened for a reason. It's not just irrational fear - people look at the circumstances then, look at conditions now, and see reason to consider them to be somewhat comparable, and therefore a reason to worry.

That's a lot better than people who think all recessions are interchangable - take all this talk you see out of guys like Tom Woods about the "forgotten depression" of 1920. Qualitatively, 1920 bears no resemblance at all to 1929 or 2008, but Woods talks as if what caused 1920 caused every other recession - what solved 1920 would solve every other recession - what Keynesians proposed in 2008 they would have proposed in 1920.

Most of the over-leveraged folks in real estate that I know regard inflation as their only salvation. Even those that are still managing to service their debts, but are able to do little else are hoping for a general rise in the price level, so they can raise rents. Can you blame them? The question is how prevalent is that attitude, does it apply to other sectors, and is it having an effect on government policy?

I am thinking that the concern over deflation is largely related to trying to escape a credit squeeze, and a deflationary episode may very well reopen the whole mess in the banking system all over again by creating a debt deflation problem. Combine that with the tendency of the CPI to overestimate inflation, and the cause for being skittish is understandable.

That being said, I'm not entirely convinced that deflation is likely to happen anytime soon, although this concern about "deflation" may simply be cover for trying to target a higher-than-normal rate of inflation in hopes of letting it unwind the credit situation.

RE: "It is weird to me that some people are still worrying about deflation"

Haha - the feeling is mutual. Actually, I'm not sure if anyone is still worried about deflation per se - more afraid of extremely low inflation. This is a recovery from a major drop in the price level. After you take that bounce-back into account, do you think there's any reason to worry about persistent inflationary pressure? I think you're fairly unique if you see such pressures on the horizon. Even your colleagues at Econlib have been dismissing such concerns lately.

And I should add that the people that are worried about low inflation want to encourage climbing price levels... so if they are proven wrong you've got to ask "was their analysis wrong" or "were they successful in their deliberate efforts to overcome low inflation or deflation"? And of course you can still dispute their analysis or the value of their efforts - but you've gotta engage those two alternatives if we do end up with mid-level inflation in the next couple years.