From Bad to Worse: Reaction to Arthur Laffer

Read the WSJ article by Arthur Laffer, "Get Ready for Inflation and Higher Interest Rates", at the following link:  http://online.wsj.com/article/SB124458888993599879.html

Mr. Laffer makes a convincing sounding arguement to contract the monetary base in order to stem the tide of inflation.  However, in his last paragraph he grazes over the "sharp pain of a deepened recession" that would result in the short run if money supply were contracted.  He seems to neglect a few key things: the expanded money supply is meant in the short run to get us out of the recession, and that the Americans who would feel the sharp pain of this are real people. 

Contracting the money supply is a tool that the Fed can use prevent inflation, and Mr. Laffer argues that the increased money supply we have now is not necessary in order for banks to lend out assets, so this will be fine.  He also says that a decreased demand for money (liabilities) will result in inflation and higher interest rates.  The short run inflation rate and interest rate increases will encourage economic growth, however.  It is favorable to the borrower to use the money for investments in this circumstance, since higher inflation rates in the future mean that the real value of the loan is now lower than when they originated it, though the nominal value stays the same.  Investment is a key aspect of stable economic growth in the long term future.  Contracting the supply at this point would put the borrower at a disadvantage and discourage investment.  High interest rates also increase savings investment.  Contracting the monetary base would greatly stunt economic growth, which is the key reason the monetary base was expanded during the recession in the first place.

Keynesian economists would say that the contraction of supply should only occur when the economy is consistently growing.  At that point, it would prevent too much growth and reduce inflation and interest rates, at a time where supply is high enough that inflation distortion and high interest rates are no longer needed as incentives to invest.