The policy response to financial crisis has, in effect, given us a great natural experiment in macroeconomics — an experiment that can and should be viewed as a test of two views of the economy. One view — which includes both freshwater macro and much of what Austrians say — is in effect classical macro as Keynes described it, in which the economy is always constrained by supply. The other is a more or less Keynesian view in which a depressed economy is constrained by demand, not supply.

These two views had strong implications on three fronts. One was interest rates: would large budget deficits drive rates up, as a classical view implied, or would they do no such thing under depression conditions? A second was the effects of austerity (which has been much larger than the weak efforts at stimulus, and therefore provides the real test); would austerity policies release resources to the private sector, as per the classical view, or lead to economic contraction? Finally, a third implication involved inflation: would large increases in the monetary base produce soaring inflation, again as classicists of all kinds claimed, or do no such thing under depression conditions?

You know how things have gone on the interest rate and austerity fronts. Let’s do an update on inflation.

Early last year the inflationistas were yelling a lot; commodity prices had jumped, and they were shouting that high inflation was just around the corner, with much talk of debasing the currency and all that.

Whoops.

A couple of further points. One refuge of some of the inflationistas has been to claim that the feds are cooking the data, that true inflation is much higher than reported. You can take those claims apart in detail, but a simpler answer may be just to look at independent inflation measures, like MIT’s Billion Prices Index:

No hint of book-cooking there.

One other thing that has become clear is the usefulness of the concept of core inflation. The measures we have are imperfect reflections of the Platonic ideal; still, keeping your eye on core inflation has been a much better strategy than following the ups and downs of the headline rate:

To be fair, I and other have been surprised by the stubborn persistence of low core inflation; if you’d asked me three years ago, I would have predicted slight deflation by now. My current interpretation is that downward nominal wage rigidity is a bigger issue than we realized. But this is a relatively small failure of prediction compared with the dire forecasts of soaring interest and inflation rates.

Finally, I just want to flag this for the record:

Regardless of what the triumphant Keynesians would have you believe, my analysis continues to be that the current combination of monetary and fiscal stimulus is driving us toward disaster. Instead of a real recovery, the US will experience an inflationary depression. Europe, on the other hand, will suffer much less, precisely because it was not seduced by the short-term appeal of stimulus.

Yep.