Greenspan worries about inflation

Former Fed Chairman Alan Greenspan opined in the Financial Times late yesterday that inflation will pose the greatest challenge to the global economy over the next few years. "Excess capacity is temporarily suppressing global prices," Greenspan said.

He added, "If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply."

Monetary policy always works with a lag. The difficulty is anticipating whether or not the huge amounts of economic stimulus already in the pipeline from the Fed and world central banks will be enough to lift the economy out of the current mess.

Given that signs are growing that we are near the end of the recession in the US, it appears that actions taken by the Fed are having the designed impact.

Although the debate as to when and how quickly to remove the monetary stimulus is raging among policymakers, I suspect that no one wants to be blamed for stomping on the green shoots that have begun to emerge.

And the Fed will probably err on the side of caution as it withdraws liquidity and starts raising rates. Note in its last two statement, the FOMC said it plans to keep the fed funds rate at low levels for "for an extended period."

Greenspan's easy monetary policy probably contributed to the current mess, but he provides a strong argument when it comes to his concerns about rising prices over the longer-term.