The ketchup theory of inflation

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The ketchup theory of inflation

The ketchup theory of inflation
May 28th 2010, 9:15 by Buttonwood

SHAKE the ketchup from the bottle/first, a little, then a lottle. We've all struggled to deal with Heinz's best known variety. And the pseudoplastic nature of the sauce helps explain why quantitative easing could, if things go wrong, end up in hyperinflation. As Tim Lee of pi Economics suggests

The central bank keeps "shaking the bottle" (ie monetising debt) but no ketchup (ie inflation) comes out - so it shakes even harder. In the end, the ketchup comes out in an inflationary rush.

Tim Lee argues things may be even wose than this analogy. Because the central bank's efforts initially appear to fail, people will be more inclined to hold money because of deflationary fears. The central bank will have to monetise debt even faster.

At that point the demand for money will begin to reverse. Finally confidence in money will be lost and an initial rise in inflation will quickly turn into a hyperinflation. The central bank's balance sheet will have been expanded so enormously that it will be impossible to reverse this.

 Dylan Grice, the Societe Generale strategist, has similar worries. He says that that central banks will keep printing money uintil the financial system stabilises and worry about removing liquidity later.

Printing money to finance government expenditure is a very well trodden path which is as old as money itself. With government balance sheets in such a mess across the developed world (even with yields at historically unprecedentedly low levels), government funding crises are likely to be a recurring theme. Since banks hold so much "risk free" government debt, those funding crises point towards more banking crises which point towards more money printing. When do they stop? When can they stop?

Given the current sluggish money supply growth, I don't think this is a problem in the short-term. But if we head into a deflationary double-dip, then the ketchup principle may be a worry for later in the decade.

A U.S. Government bond bubble   ( worth the read)

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