Chairman Bernanke is aware of the danger of massive inflation, and in fact many of his critics have accused him of pumping in new reserves much too slowly. There is still time for him to reverse the process and drain away the excess, just as the Fed did after it had briefly flooded the market leading up to the Y2K scare. However, Bernanke may be in a very difficult position if the credit markets are still on life support from the Fed once prices begin rising rapidly. He may find in a few months that his efforts to rescue the banking sector have pushed him into a corner, where he must choose double-digit inflation or collapsing banks.
The scenario described above would be difficult terrain for any administration. But with a President Obama and a solid Democratic Congress, the federal “solutions” will only multiply the pain. We can easily imagine the new president denouncing greedy profiteers for the soaring prices of milk, bread, and gasoline, and to impose “anti-gouging” penalties, if not outright price controls. This in turn would lead to shortages and long lines, as in the 1970s and even more recently when several state Attorneys General threatened retailers not to raise gasoline prices in the wake of Hurricane Ike.
Naturally, I have painted only one possible chain of events. We may very well limp along and eventually recover after a moderate recession. Yet it should concern citizens that the federal government has already resurrected several plays from the New Deal handbook. The last time we tried this, we had a decade of stagnation and massive unemployment. It’s very possible that the experiment is about to be repeated.