How We'd Do It

John Carney at NetNet rightly notes that logistics could be a challenge here. Uncle Sam can't just point his finger and prices rise. He imagines that government spending, using newly printed money instead of debt, is one way this could occur. But he believes that the recent debt ceiling debacle shows that such an option isn't politically palatable. He's right, and other ways to inflate the U.S. currency look equally as problematic.

Free Money for Everybody!

Instead of spending the money it prints itself, what if the government sent this money directly to the people? Let's say each American got a check the mail for $10,000. That would cost about $3.1 trillion. And let's say that it was taxable income -- so some of that would also go to deficit reduction. The rest could be spent freely. If this doesn't raise inflation by enough to cure the problem, do it again next year, and so on.

Even if Congress somehow agreed to do this, would it necessarily result in consumers' loan burden declining? Some Americans might spend that money right away. But others might use it towards a down payment on a home or car. Maybe they buy more expensive stuff that require more expensive accessories, causing them to increase their credit card balances. Just because people have more money to spend doesn't mean that their appetite for credit would disappear. Indeed, they might want even more.

Fed Sets a High Inflation Target

Another option could be for the Fed to step in. It could establish an inflation target, but set that target quite high, at say 6%. This wouldn't necessarily cause inflation to rise, but it could have severely negative consequences for the U.S. The market would come to view the Federal Reserve's price level control as an exercise in convenience. The market would come to believe that as soon as it becomes advantageous for inflation to be higher, the Fed will just raise its inflation target.

As a result, investors will be very wary when it comes to U.S. dollars and U.S. public and private debt. It will begin to distrust the U.S. central bank. Even if the Fed eventually restates its goal to keep inflation at a low, stable rate, the market can point to this episode as an example of the central bank's whimsical attitude towards inflation. It may take several decades for the Fed to rebuild its reputation, and by then the U.S. might soon be faced with yet another "Great Contraction," which renew investors' concern about high inflation.

And in the case of the U.S., in particular, a tarnished reputation would be particularly harmful. Currently, the U.S. dollar is the global reserve currency of choice, and Treasuries are considered the safest among debt securities out there. If the U.S. consciously calls for higher inflation to get out of its current mess, then global investors might decide that there's nothing special about the U.S. dollar after all. The loss of this global competitive advantage would be worse than even a lost decade.