The chaos that has engulfed financial markets, with new rumors of European bank failures, arose as it became apparent that recovery was unlikely until something was done to write down bad debts, whether American mortgages or Greek government loans, or to make them good again by raising asset values and thus increasing the ability to repay.
And yet the anti-inflation warriors continue to fight old battles. There were three dissents from regional Fed presidents when the Fed promised this week to hold down rates for at least two more years. The European Central Bank has been raising rates on the belief that it must vigorously fight any sign of inflation.
In the future, central banks will have to realize that debt-financed expansions in asset prices can be a threat. For now, it would be nice if they would at least recognize that major deflations in asset prices can be much more important than the relatively small gains in commodities that show up in the Consumer Price Index.