"Just what the doctor ordered? Most investors and central bankers seem to believe that the extreme monetary policy accommodation in the US and Europe is exactly what the doctor ordered in an environment where fears about double-dips, deflation and massive fiscal tightening abound, and where the banking sector, especially in Europe, is still struggling. However, we believe that these fears are overdone: we continue to say ‘no’ to the double-dip, we continue to worry more about the longer-term inflationary risks associated with extreme monetary accommodation, and we doubt that governments in the US and in the large euro area member states have the resolve to tighten fiscal policy drastically.
Or rather overmedication? If we are right, then central bankers and investors may be in for a rude awakening once it becomes clear that monetary policy has remained too expansionary for too long. Then, monetary policy will face an awkward choice between allowing inflation to run its course and raising interest rates aggressively despite high debt levels. Our suspicion is, as we have explained in the past, that they would opt for the former – allow higher inflation for some time in order to help reduce the debt burden."
