Monetary policy — as well as fiscal policy — is faced with the additional problem of a fundamental imbalance between production and consumption in the US. The US consumes too much to the tune of 5-6% of GDP, relying on foreign production to deliver the excess.As Brad DeLong and others have long said, our current account imbalance and the huge buildup of dollar-denominated bonds in the hands of the Bank of China can't go on forever. The only question, really, is whether we manage to unwind this with a moderate amount of pain or a huge amount of pain. The jury is still out on that.
[Driving down the Dollar helps fix this imbalance. But this produces inflation, and unfortunately, domestic structural adjustments will probably provoke policy changes that make the inflation even worse.]
The inflation, of course, serves a purpose — it is a market response to excessive consumption. Policymakers who want to pretend that the fundamental economic problem is insufficient demand rather than excessive demand will find the market yields a solution — higher inflation to depress consumption via declining real incomes and wealth. Not a pretty solution, but a solution. Perhaps we are well past any other solution.
TOO MUCH CONSUMPTION....Via Mark Thoma, Tim Duy offers a gloomy view of our current economic predicament. He agrees that fiscal stimulus isn't likely to help much given that our big problem right now is widespread insolvency in the financial sector, and then adds this: