Alan Greenspan Sees Inflation

J. Scott Applewhite/Associated Press Alan Greenspan in his Washington office last week.

Alan Greenspan, the former Federal Reserve chairman, has largely avoided public comment on the Fed’s efforts to stimulate the economy, but he has said enough to make it clear that he is not a fan.

The latest volley, from his new book, “The Map and the Territory,” is a warning that the Fed’s balance sheet expansion â€" $3.8 trillion and counting â€" may unleash inflation.

“It is easy to contemplate price acceleration, with today’s Federal Reserve balances unchanged, ranging from 3 percent per annum to double digits over the next 5 to 10 years,” he writes.

It’s been a long time since anyone accurately predicted higher inflation. Instead, inflation has sagged to the lowest levels on record. But here’s why Mr. Greenspan is worried.

Each time the Fed buys a bond, it pays the bank that sells the bond by creating money and putting it into an account that the bank keeps at the Fed. Mr. Greenspan’s inflation prediction is based on his estimation of the consequences as that money flows out into the economy.

The Fed could neutralize this threat by selling the bonds, sucking the money back out of the economy. Fed officials are confident in a second plan: The Fed pays interest on the money that banks keep on deposit, and as the economy improves, the Fed can increase the interest rate to induce banks to keep the money on deposit, eliminating the inflationary pressure.

Mr. Greenspan acknowledges this possibility, but he wonders aloud whether the Fed will have the courage to act. “Unless the economy unexpectedly moves quickly into high gear, any credit tightening will, as usual, run into considerable political opposition. It always has.”

Against these fears is the possibility that inflationary pressures simply won’t build until the economy has kicked into higher gear. Or, even if the Fed should happen to face inflationary and political pressures simultaneously, there is also the possibility that the Fed will do its job.