The growth in the debt from the accumulated deficits would have expected to increase inflation according to most economic models. There are several theories why this has not occurred.

The decrease in velocity, the turnover of money, has muted the effects of monetary growth. Milton Freidman assumed a stable velocity in his monetary theories, but fiscal friction costs and personal debt reduction has reduced the consumer and investment incentives until recently. Much of the money creation to buy the toxic assets during the 2008 crisis had a less stimulative effect, and banking policy following the crash did not encourage consumer lending as we would have normally expected.

Another theory I call the ‘tallest midget theory’ suggests that as bad as our fiscal situation was it was better than any other place in the world. European nations drove interest rates into negative territory to push money into the economy. Low interest rates in the United States drove money into the stock market as older investors took greater risk in order to supplement the higher yields of yesterday.

The low inflation rate may be masking actual deflation. Do we have 2% inflation or 4% inflation in what otherwise would be 2% deflation? Are we importing deflation from Europe?

All of this suggests how little we really know about the causes and how careful we should be about policy depending on models developed in a different economic environment. We should also be very careful and skeptical about new models being developed to explain the current scenario. Accurate descriptions do not assure accurate predictions.

Modern Monetary Theory or MMT is a new school of thought that suggests deficits do not matter as much as we thought. It may offer an explanation to the lack of inflation in the face of growing deficits, but we should be cautious about considering it for serious policy. Economist John Cochrane examines it in his blog The Grumpy Economist in Smith, MMT, and science in economics:

In fact, formal models don’t totally speak for themselves, especially on the research frontier. New-Keynesian models are a good example since there is an active debate on just what the equations say and how to interpret them. I’ve devoted a lot of energy to this debate. It is conducted in the pages of peer-reviewed journals. There is, or was, an active debate on what the equations of quantum mechanics and general relativity say too. And while the occasional testable prediction makes for spectacular rhetoric, economics like other non-experimental sciences is pretty thin on testable predictions. Otherwise, we would still not be debating what really caused the Great Depression, whether minimum wages help or hurt disadvantaged people, whether the government borrowing money and spending it, even on totally useless projects, stimulates the economy or not.

But these ideas have clearly not yet made it in to that mainstream. The real question is, when is an idea ready for widespread implementation in public policy? How much of the sociology of science should we wait for before spending trillions of dollars? Though some good ideas have indeed been disparaged by the mainstream and took a long time to be accepted, there are so many bad ideas out there, that I think the answer is, a bit longer.

Descriptive powers do not naturally unfold into predictive accuracy. Models by their nature must eliminate variables that can be critical. An economy as large and as dynamic as ours is a wonderful and complicated thing and not cooperative to descriptions and predictions according to simple models.