Understanding Inflation, define inflation, causes of inflation, economic inflation

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UNDERSTANDING INFLATION

SO, WHAT'S TO WORRY ABOUT, ANYWAY?

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FUTURECASTS online magazine
www.futurecasts.com
Vol. 6, No. 2, 2/1/04.

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Economic inflation:

Policies that hold prices down can be inflationary.

When we think of inflation - when we define inflation - we think of rising prices instead of the actual causes of inflation. This is reasonable, since the ultimate outcome of inflation is always a general and sustained increase in price levels. It is thus easy to define inflation in terms of its ultimate results - the price increases that it causes - and ignore the underlying causes of inflation - the underlying forces that caused those results.
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This is no minor matter. It leads to the common policy mistakes that arise from the belief that anything that holds prices down is "anti-inflationary" - when the opposite is often actually true.
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Price controls and the expenditure of financial reserves subsidize inflationary levels of demand and deter increases in supply, and are thus inflationary.

  It is the price rises themselves that are "anti-inflationary." The measures often employed to hold down price increases are actually additional forces of inflation that will cause even further price increases in the future.
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  Price increases are anti-inflationary. Price increases powerfully assist in reducing demand and increasing supply so that inflation can be brought to a halt.
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  Price controls below market rates and/or the expenditure of national savings (financial reserves) to hold down monetary devaluation are inflationary. Price controls and the expenditure of financial reserves subsidize inflationary levels of demand and deter increases in supply. They make it much more difficult - much more painful - to bring inflation to a halt and restore healthy and sustainable economic growth.
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Many people have vested interests in the simplistic and invalid concepts that define inflation in terms of the price increases that it causes. This fallacy is widely accepted without critical analysis.

By defining inflation simplistically in terms of the current rate of price increases - economists, politicians, and others with vested interests in the continuance of the policies actually causing inflation can pretend that inflation doesn't exist or can minimize its extent for the long periods when inflationary forces manifest themselves in ways other than in pushing prices higher.
Econometric technicians - who have to ignore all economic factors that cannot be expressed as equations - and have to reduce all recognized economic concepts to the simplistic point where they can be mathematically measured or weighted - are forced to ignore the existence and extent of inflationary forces until those forces cause price increases that can be measured. This is like those medical tests that never show what is wrong until the patient is already half dead.

Price inflation statistics:

However, this does not mean that it is wrong to use the extent of price increases to measure the scope of inflationary forces - as long as this is not done simplistically (as it almost always is). These statistics must be evaluated in view of a variety of poorly measured factors. The evaluation must recognize that the price statistics cover just a part of the problem - and that even that coverage is very inaccurate.
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Modest rates of price deflation - in excess of one percent per year - were the rule in the 19th century, when the dollar was tied to gold and the United States became a wealthy economic powerhouse.

Monetary inflation is actually a tax by which government - by expanding the money supply - transfers wealth from its people to itself.

It also results in the transfer of enormous amounts of wealth from the hands of ordinary people to the hands of those speculators shrewd enough to take advantage of the price volatility inflation causes in the markets.

   Indeed, the measurement of inflation is notoriously inaccurate. The government and many people have a vested interest in these inaccuracies, because benefits due under social security and other government programs - or under labor contracts and commercial contracts - may be indexed to the inaccurate figure.
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  On the one hand, "price inflation" statistics are overstated because they don't reflect increases in the quality or variety of commercial goods and services offered - or increases in the productivity of productive assets produced. They are slow to reflect new products, which are often the beneficiaries of especially rapid increases in productivity (although this last weakness has been diminished somewhat in recent years - and indeed may well have been reversed).
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  On the other hand, "real inflation" statistics are understated because they measure "price" inflation instead of the pressures that cause price inflation. They also generally omit asset price inflation, which is real inflation and enormously destabilizing.
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  Prices would decline about three percent per year to reflect the increase in productive efficiency of our rapid technological progress - if government were not creating inflationary pressures. Indeed, except during the years of the gold rush and the Civil War, modest rates of price deflation - in excess of one percent per year - were the rule in the 19th century, when the dollar was tied to gold and the United States became a wealthy economic powerhouse.
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Today, even when there is little "price" inflation, stable prices just mean that government, by printing more money or otherwise expanding the money supply ("monetary inflation"), has appropriated for itself all the price benefits of each year's increase in productive efficiency.
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Monetary inflation is actually a tax by which government - by expanding the money supply - transfers wealth from its people to itself. Indeed, inflation is perhaps the most destructive tax that can be imposed - but unfortunately it is the easiest one for a government to impose on its people. It also results in the transfer of enormous amounts of wealth from the hands of ordinary people to the hands of those speculators shrewd enough to take advantage of the price volatility inflation causes in the markets.
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With productivity gains running in excess of three percent, and prices rising in excess of two percent, the real rate of inflation is already currently well in excess of five percent - representing a capital levy of five percent (as of the beginning of 2004).

At current levels, the forces of inflation have achieved considerable momentum, and the effort to bring inflation back under control is likely to cause some real economic distress.

The pertinent statistics are grossly inaccurate, but even when very conservatively evaluated, inflationary forces in excess of 5 percent are indicated. At current levels, the forces of inflation have achieved considerable momentum and thus are proving more troublesome to control and reduce than expected. Even at current levels, the effort to bring inflation back under control - to where price inflation can be contained below 2 percent - is likely to cause some real economic distress. If inflationary forces are allowed to get much stronger, the economy would begin to revisit the problems of the 1970s. See, Meltzer, History of the Federal Reserve, v. 2 Part VI, "Nixon Devalues the Dollar, (1960-1973)," and Meltzer, History of the Federal Reserve, v. 2, Part VII, "The Great Inflation (1973-1980)."
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Indeed, the U.S. will soon begin paying for the monetary expansion loosed in the effort to deal with the recent (2001) recession. (Indeed, the Credit Crunch recession in 2008 was the result.)
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So, then, just what is the proper definition of "inflation?"

Defining "inflation:"

From the foregoing analysis, it is clear that we must carefully distinguish several related but separate concepts.

One of the unfortunate consequences of heavy reliance on debt financing is to turn the great benefits of price deflation into a severe threat to the debt-laden financial structure of the economy.

"Monetary inflation" is simply the artificial expansion of the money supply, and is historically the primary engine of inflation. It pleasantly enables demand to increase before any increase is produced in supply.

This "cause" is so dominant that it should be the first thing that comes to mind when referring to "inflation" during peacetime. "Clipping the coinage" was, historically, the first method used, followed shortly by "debasing the coinage." In the 1960s, the United States substituted baser metals for the traditional silver content in its coinage. "Running the printing presses" arose with the advent of paper money. This was practiced most notoriously by the central bank of the Weimar Republic, which tried to stay ahead of the loss of purchasing power caused by price inflation by "maintaining liquidity balances."
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Today, under Keynesian "monetary policy," the money supply is easily expanded through open market purchases of government short term obligations - a "monetization of debt" - usually involving nothing more than the changing of notations on financial accounts from government bills to cash - and by shortening the average term of government debt and other modern credit based methods of expanding the money supply. For a detailed explanation of how the U.S. Federal Reserve System was transformed into an engine of inflation, See, Meltzer, "A History of the Federal Reserve, vol. 1 (1913-1951)," Part I, "The Search for Stability (1913-1923)," Part II, "The Engine of Deflation (1923-1933)," and Part III, "The Engine of Inflation (1933-1951). For a broader view of U.S. monetary history, see Friedman and Schwartz, "Monetary History of the U.S. (1867-1960)," Part I, "Greenbacks and Gold (1867-1921)," Part II, "Roaring Twenties Boom - Great Depression Bust, (1921-1933)" and Part III, "The Age of Chronic Inflation (1933-1960)."

"Price inflation" is the market's natural unpleasant "deflationary" reaction to monetary inflation. By reducing the purchasing power of all currency in circulation, and by reducing the purchasing power of credit based on assets, rising prices powerfully if somewhat belatedly counteract the pleasant artificial increase in purchasing power that is the purpose of monetary inflation. Price inflation tends to reduce demand and increase supply.

The pleasant delay between the cause (monetary inflation) and this effect (price inflation) can be extended by expending financial reserves of gold and hard currencies to support the value of the inflated money. After WW-II., the United States expended most of its huge hoard of monetary gold to extend this pleasant period for two decades.

"Real inflation" is the rate at which inflationary causes would impact price levels if all inflationary causes were considered and the time gap were eliminated. Since precise measurement is impossible, this is essentially an evaluative process, producing a figure or range of figures that constitute fairly inexact estimates.

Among other inflationary causes - besides monetary inflation - are price controls and the expenditure of monetary reserves - both of which ultimately inhibit the growth of supply and sustain the period of artificially expanded demand. Of course, price inflation is an important part of the estimate of real inflation. However, so is the estimate of productivity growth - which would beneficially lead to reduced consumer costs but for inflationary forces.
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One of the unfortunate consequences of heavy reliance on debt financing is to turn the great benefits of price deflation into a severe threat to the debt-laden financial structure of the economy. Increases in quality and variety are among the other factors that are impossible of exact measurement, but that must be factored in.

"Inflationary forces" are what we really should be talking about when we speak of "inflation." These include all forces that increase demand without relationship to supply, or that decrease supply without any relationship to demand.

In addition to the expansion of the money supply, this includes such factors as price controls, and expenditure of substantial percentages of monetary reserves (which tends to immediately hold down price increases, and to ultimately increase financial risks and interest rates throughout an economy). Business taxes and import tariffs have an inflationary impact because they directly decrease the productive efficiency with which the economy produces goods and services.
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Price increases:

To be functional, the definition of "inflation" has to encompass that which is "inflationary" - the economic forces that ultimately cause general and sustained increases in price levels. It must NOT include the price increases themselves - even though it is proper to use those price increases as one of the important factors in measuring inflationary forces. It must NOT formulistically confuse cause with just one of several possible effects - no matter how important that particular effect might be.
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The economy must suffer a painful decline in demand upon cessation of the stimulatory causes of inflation. Even though inflation is easy to stop as a theoretical matter, this is why it is so difficult to stop as a practical matter.

   To begin with, not all price increases are the result of the forces of inflation. General increases in price levels can occur as a result of normal temporary cyclical upswings and the higher credit utilization levels that normally accompany prosperous times. General increases in price levels can also occur as a result of supply disruptions caused by labor unrest, political turmoil, or war, which can increase prices only temporarily unless "accommodated" by an increase in the money supply - which frequently happens.
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  While price increases are the most usual result of the buildup of inflationary forces, and are invariably (although not theoretically unavoidably) its ultimate outcome, the buildup of inflationary forces can proceed for years, or even decades, before manifesting themselves in rising prices. Even when inflationary forces begin to cause problems, they can disrupt an economy in many ways other than by pushing prices higher.
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  Generally, after an initial period of pleasant increased demand and broad economic stimulation, inflation manifests itself not just in rising prices, but in an increase in economic dependency on continued inflationary stimulation, and in a decrease in the purchasing power of credit. It may induce the imposition of price controls and the expenditure of reserves. The increasing economic dependency on continued inflationary stimulation obviously begins long before prices start rising.
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An increase in imports unaccompanied by an increase in exports is a vital factor during initial inflationary phases that undermines payments balances and ultimately forces currency devaluation. This is a key weakness in Keynesian palliatives widely ignored by Keynesian economists but emphasized by the publisher of FUTURECASTS for 40 years. See, Blatt, "Dollar Devaluation," (1967).
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  Economic dependency and adverse credit shifts are far too complex to be fully expressed as equations or accurately reduced to mathematical terms or derived from our crude economic statistics. Distorted economic and financial flows - adverse impacts on international trade and payments balances - increases in nominal interest rates - and increases in perceived financial risks are among the early unpleasant effects of monetary inflation.
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  However, this dependency and reduction in purchasing power is the reason why, even at an early stage, austerity policies - the cessation of the stimulatory policies that gave rise to the inflationary forces - will cause an economic slowdown. This is why inflation is so painful to stop.
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  Inflation is like an addiction. The economy must suffer a painful decline in demand upon cessation of the stimulatory causes of inflation. Even though inflation is easy to stop as a theoretical matter, this is why it is so difficult to stop as a practical matter.
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Price controls:

An obvious example of reduced purchasing power occurs under price controls. With prices fixed at official levels, economists and politicians can - and routinely do - ignore obvious decreases in purchasing power and claim that there is no inflation.
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For many years, a substantial proportion of our economists made the ridiculous assertion that WW-II price controls kept inflation at about one tenth of the actual loss of purchasing power that took place during that period. Prices on the black (free) markets, and the ultimate surge in prices in the year after prices were set free, more accurately reflected the real extent of inflation during WW-II (about 50 percent in just four years).
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Under energy price controls during the 1970s, the cost of gasoline was routinely understated by ignoring its limited availability and the time and energy wasted in obtaining it. Ultimately, price controls became both inflationary and depressing (stagflationary) at the same time. When set artificially high by the imposition of new taxes, prices inhibited consumption without inducing the production of new supplies.
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Reserve currencies:

A general liquidation of savings and reserve assets is another way in which inflation can manifest itself with or without rising prices. For two decades after WW-II, the United States was able to ignore the inflationary implications of its inflationary economic policies by selling off its huge holdings of gold. Just as boiling water carries off heat and prevents any further temperature increases within a pot, the sell-off of reserve assets dissipated inflationary pressures and temporarily shielded consumer prices from those pressures.
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The hard currency status of the dollar provides the U.S. with enormous benefits, that must not be jeopardized.

   Of course, when reserves ran low, it became obvious that the credit of the United States had suffered a substantial albeit not precisely measurable decline in purchasing power. During those two decades before the exhaustion of gold reserves, inflationary forces were permitted to build to a prodigious extent - hidden from public view - and generally ignored by politicians and economists alike.
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  Inevitably, the reserves ran too low to continue to support the inflated dollar. Then, the dollar was devalued and the economy was left unprotected before the forces of inflation. The business cycle turned vicious, and double digit woes afflicted the economy - all to the evident befuddlement of most of the nation's most prominent economists.
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  The dollar and other hard currencies constitute a valuable service to the world, for which the world pays handsomely. Valuable goods and services, raw materials, facilities, securities and other currencies, can be acquired in world markets in return for nothing more than monetary paper or appropriate notations in monetary accounts. The profit margin on this service is enormous. When the securities of hard currency nations are held as reserves - as a store of value - the interest expense to the issuer nations is minimal. When hard currency circulates as a medium of exchange in international markets, the profit margin for the issuing nation approaches the proverbial 99 and 44/100 percent mark.
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  However, like any other service, reserve currencies are subject to the laws of supply and demand. Moreover, if the supply is perceived to be chronically expanding above demand, the ability to provide this profitable service can substantially decline - as happened to Great Britain and its pound sterling during the first eight decades of the 20th century. Status as a reserve currency can even disappear.
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  When evaluating the inflation of the money supply and the balance of payments deficit of the United States, it is vital to subtract from those figures the dollars and government securities readily absorbed by the world for use as a reliable store of value and medium of exchange.
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  When considering the risks of inflation, it is vital to keep the risk to the dollar's hard currency status in mind. Its hard currency status supports the dollar and dampens the impact on consumer prices of inflationary policies in much the same manner as gold reserves. However, those inflationary policies threaten the hard currency status of the dollar.
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  The status of the dollar as the world's primary reserve currency makes it practically impossible to directly evaluate the degree to which "expenditure" of monetary reserves is currently shielding the United States economy from the consequences of the inflationary expansion of its money supply. The notorious and constantly worsening inaccuracy of balance of payments statistics further undermines efforts to evaluate payments problems. (According to "The Economist" of 5/27/00, the World was at that time running a payments deficit of almost $250 billion. It's a good thing we've finally gotten Mars to stop rejecting our exports.) However, there are indirect methods for judging payments trends.
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  General interest rate ranges compared to those historically normal when the dollar was tied to gold, performance of the dollar on international money markets, and the performance of commodity price indexes (especially gold), provide the primary indirect tools for evaluating the extent to which dollar outflow constitutes an expenditure of the dollar as a monetary reserve. So far, except for interest rates, these omens are obviously deteriorating.
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The many faces of inflation:

Even when inflation manifests itself in rising prices, the measurement of the general impact is far from simple. Rising interest rates - reduced price/earnings ratios for equity investments - increasing international payments and trade deficits - the loss of economic flexibility, stability and resiliency - the growth in debt levels and a shift from long term to short term financing - the perception of a general increase in financial risks - the increasing emphasis on short term results - all significantly reduce a nation's financial health and economic prospects in ways that can't be precisely measured. They are all among the many faces - the many effects - of inflation.
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   In the private sector, high interest rates have their most dramatic impact on equity investments - both stock market and private. High interest rates undermine equity investments in several ways.
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  One of their most important impacts is as a direct competitor for the investor's dollar. By increasing the difficulty of raising equity capital, high interest rates directly undermine financial stability and slow the growth of economic capacity needed to meet inflationary demand. They reduce price/earnings ratios.
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High interest rates obviously increase economic costs and risks both for the individual business and the economy as a whole. In addition, high interest rates obviously reduce incentives for long term economic projects.
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  High interest rates reduce borrowing for consumption, production and investment purposes. Ultimately, efforts to keep interest rates down by means of rapid money supply increases MUST lead to higher interest rates than would otherwise occur.
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So, then, what is the functional definition of "inflation?"

The process of "inflation:"

Inflation is a process, not a thing. The real problem is thus to define those factors that cause inflation - those factors that are "inflationary."
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That which increases demand without immediate relationship to supply, and that which reduces supply without immediate relationship to demand, is "inflationary."
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Also, that which prevents or inhibits the growth of supply to meet increased demand, and that which prevents or inhibits the reduction of demand to conform to a supply reduction, is "inflationary." Such government policies as expansion of the money supply, restraints on international or domestic commerce, and controls on prices, profits, rents or interest, all fit this definition.
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So, then, what is the functional definition of "deflation?"

The causes of "deflation:"

When prices decline due to productivity increases, the declining prices powerfully increase purchasing power and demand even as the productivity gains increase supply.

   Deflation is a process, not a thing. The real problem is thus to define those factors that cause deflation - those factors that are "deflationary."
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  PRICE INCREASES ARE OBVIOUSLY DEFLATIONARY - NOT INFLATIONARY.
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  Price increases powerfully induce increases in supply and decreases in demand - which tend to diminish and even throw into reverse the forces pushing prices up.
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Productivity increases are not deflationary even when they cause prices to decline. Productivity increases stimulate both supply and demand in ways that can be balanced and healthy for economic growth. When prices decline due to productivity increases, the declining prices powerfully increase purchasing power and demand even as the productivity gains increase supply. However, the impact of the price declines on a heavily indebted economy can be deflationary. But that is a function of the debts, not of the productivity increases or the productivity induced price declines.
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Processes of inflation and deflation will generally be at work at the same time. By the time inflation manifests itself in rising prices, it is powerful enough to overcome the reemployment of unemployed labor and productive assets. It is powerful enough to overcome the balanced processes of productivity gains as well as the deflationary processes caused by the inflation - including ultimately increases in unemployment of labor and capital assets.
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Ultimately, there is no tradeoff between inflation and unemployment. Chronic inflation ALWAYS ultimately causes unemployment of labor and capital assets. It is only in the short run - which for most nations is just a few years in duration - that inflationary policies such as those advised by Keynes can reduce unemployment.
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Because of self-correcting market mechanisms, only government can cause runaway inflation or chronic depression.

We must carefully distinguish causes from effects. The causes of inflation cause the effects that, although naturally associated with inflation and responsible for much of its economic pain, are actually deflationary and must inevitably - if permitted - quickly bring inflation to an end and help restore the basis for healthy economic growth. Similarly, causes of recession cause the effects that, although naturally associated with recession and responsible for much of its economic pain, are actually stimulatory and must inevitably - if permitted - quickly bring recession to an end and help restore the basis for healthy economic growth. Unfortunately, however - as stated above - an economy heavily dependent on debt financing rather than equity financing, and heavily dependent on debt financing for consumption rather than for investment, may collapse as a result of price deflation. This can effectively eliminate price deflation as a powerful self-corrective mechanism for increasing purchasing power and demand and mitigating recessions. Today, a heavily indebted world fears price deflation.
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Because of these powerful correcting mechanisms in the private markets, only governments cause runaway inflations - as the United States government did in the 1970s. Because of these powerful correcting mechanisms in the private markets, only governments cause chronic depressions - as the United States government did during the 1930s.
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Inflation never "runs away." Only by stupidly persisting in expanding the money supply do governments overcome the deflationary impact of price increases and impose chronic inflation on an economy.
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Whenever capitalist systems suffer chronic inflation - or suffer chronic recession or both together (stagflation - or even worse - inflationary depression) -- IT IS ALWAYS CAUSED BY GOVERNMENT POLICIES.
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Monetary expansion ("Monetary policy"):

Chronic price increases cannot occur without such stupid government policies as those that artificially increase demand and/or reduce supplies - invariably featuring some method of increasing the money supply and/or artificially holding prices at less than market levels.
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Of course, rising prices hurt - while increases in spending financed with newly created money is quite pleasant. That's why political leaders have opted for inflation so often, despite its noxious long term impacts.
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However, those rising prices are the natural way in which demand is curtailed and increased supplies are induced. They may be the natural effects of past inflationary policies - but they are clearly anti-inflationary. They will always bring inflation to a quick, natural halt, unless the unavoidable accompanying pain induces the government to "accommodate" inflation by pursuing further temporarily pleasant monetary expansion or other inflationary policies.
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Controls on prices, profits, rent, and interest:

They allow demand to remain high and deter production increases. They lead to gross distortions in economic and financial flows.

   Controls on prices, profits, rent, and interest below market rates are other commonly employed inflationary policies. They, too, are initially pleasant, but ultimately have a multitude of ill effects. They allow demand to remain high and deter production increases. They lead to gross distortions in economic and financial flows that materially and cumulatively reduce the economy's productive efficiency. They may inhibit investment - leading to stagnant capital growth (stagnant "capitalization"). Maintenance of affected assets may be rendered impractical - leading to decapitalization as productive assets are "milked."
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  Various black (free) markets and subterfuges proliferate that actually lessen the harm done by the controls. However, the entire control system must become unmanageable for any democracy and a severe constraint on living standards for a despotism.
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  Blocks of abandoned structures in the hearts of many American cities in prior decades provided mute but eloquent testimony concerning the ultimate destructive impact of rent controls and other policies that render assets relatively unprofitable.

Deficit spending ("Fiscal policy"):

Contrary to Keynesian mythology, deficit spending is not more than temporarily stimulatory. Belated recognition of this fact has come with discussion about "liquidity traps" and the failure of massive budgetary deficits to cure the chronic recession recently afflicting Japan. During the 1930s, massive deficit spending by the United Sates left the economy deep in Depression. A worsening succession of recessions afflicted the economy during the 17 years after 1965 despite constantly increasing rates of government expenditures and deficits.
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Deficit spending is generally just a pleasant substitute for the politically difficult and unpleasant policy changes needed to grapple with the real problems afflicting a troubled economy - and is thus worse than useless.

   Government borrowing and spending increases, by themselves, merely crowd out private borrowing and spending and actually tend to depress the economy. They compete with the private sector for economic and financial resources, increase "real" interest rates (the rate of interest above price inflation) and other costs, decrease economic efficiency due to the inherent inefficiency of government activities, and ultimately undermine the long-term credit of the entire nation. Deficit spending is generally just a pleasant substitute for the politically difficult and unpleasant policy changes needed to grapple with the real problems afflicting a troubled economy - and is thus worse than useless.
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  Indeed, chronic government borrowing of substantial sums is so depressing that it almost invariably forces monetization of an appreciable portion of the debt. It is this "accommodation" of the government's borrowing by expansion of the money supply that provides the temporary, artificial economic stimulation so prized by the politicians.
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  As the printing presses accelerate - the coins are clipped (or baser metals used) - the use of credit instruments are expanded - the "money supply" balloons and economic activity quickens. Politicians and economists rush to take credit for the new economic prosperity - the "obsoleting" of the business cycle - in the period prior to the inevitable arrival of higher real interest rates and/or price inflation.
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Without continuous monetization of a substantial portion of the debt, massive increases in government spending and borrowing would fairly quickly drag an economy into depression.

Inflating your way out of inflation:

Certain "supply siders" have, in recent years, done much to poke holes in the nonsense incorporated in conventional Keynesian economic wisdom about "monetary" and "fiscal" policy. However, some have adopted some nonsense of their own.
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They criticize the central bank whenever it restricts the growth of the money supply and allows interest rates to rise. They claim this prevents the economy from growing its way out of its problems. They assert that the central bank should not be concerned with inflation until the rate at which prices are rising actually begins to accelerate. This is like putting off treatment of ill health because: - "Death is nature's way of saying, it's time to slow down."
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Unfortunately, history has been invariably unkind to those nations that have attempted to inflate their way out of inflation - or out of any other problems. As stated, the initial economic stimulation is always pleasant - and always addictive because it is initially pleasant but ultimately very painful to stop. Massive international payments imbalances, the expenditure of financial reserves, rising prices and interest rates, and the flight of capital out of the country, invariably follow - ultimately building to the point of economic and - sometimes - political crisis.
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These supply-siders have forgotten that interest rates react to market interference in the same manner as any other prices. The surest way to get higher interest rates is to try to push them down.
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So, now we can see what there is to worry about.

Austerity:

Bluntly stated - stopping inflation ("austerity") hurts - and the worse the inflation is permitted to get, the more the remedy will hurt.
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The Fed can only be as strong as the dollar.

Inflation can exist for months or years before manifesting itself in rising prices, and the worse it is permitted to get, the more difficult and painful the cure. If Greenspan (now Bernanke) waits until inflation manifests itself in even higher rates of price increases, he will have to put the nation through a real recession to regain control. Already, by waiting until the dollar has weakened in international markets, the Federal Reserve has begun to lose much of its financial strength and ability to influence national and international financial and economic trends. The Fed can only be as strong as the dollar.
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Only governments can cause inflation:

Most government policies designed to mitigate the pain of rising prices are themselves inflationary and inevitably cause even more pain in subsequent periods.
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The rising prices that could stop the inflation are branded "inflationary," and "greedy" businessmen are blamed for increasing prices - while the inflationary policies that caused the price increases - the monetary expansion and various controls on prices - are all too often continued.

   These basics must be kept in mind when considering the black-is-white world of much political and academic propaganda - which the press invariably accepts without criticism or the remotest indication of understanding. The reason why so many people choose to deny reality is obvious. Curing inflation must hurt, and almost everything the politicians do to mitigate the pain will only make matters worse. No nation can indefinitely live with more than the lowest levels of inflation. "Soft landings" by means of mild levels of austerity are difficult - always impose a considerable drag on economic performance - and are slow to achieve results.
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  The politicians must have scapegoats when price increases reach painful levels. They must hide their own responsibility for the policies that have led to the turmoil. Thus, the rising prices that could stop the inflation are branded "inflationary," and "greedy" businessmen are blamed for increasing prices - while the inflationary policies that caused the price increases - the monetary expansion and various controls on prices - are all too often continued.
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  Economists who provide intellectual cover for inflationary policies (the "Keynesians") are honored and employed in high advisory positions in government.
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  When allocating blame for inflation, cause must be carefully distinguished from mere effect. Those government policies that increase demand without increasing supply, or that restrict supply or decrease productivity, are "inflationary." These government policies must bear all the blame for the rising prices, loss of purchasing power, slow or nonexistent productivity growth, capital flight, stagnant capitalization or decapitalization, stagflation or inflationary depression, and all the other ills that inflation causes.
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  Cyclical recessions can occur normally in a capitalist system due to the cumulative impact of the natural imperfections of private economic decision makers - although it is difficult to think of any recession in history where government policy mistakes did not play the primary role. However - only governments can cause inflation.

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