In a deflationary environment, few want to pay back debts with more expensive dollars later and credit-worthy borrowers are few, so borrowing and lending grinds to a halt. Purchasing slows as everyone waits for the next price reduction before buying. Redistribution of wealth via taxation is not so viable in the U.S., where economic equality is not a widely accepted political goal. Inflation is the most politically viable method of redistributing wealth from creditors and owners of capital to wage earners in the U.S. after the recession gets underway. Inflation also spurs further spending, as purchases are made in anticipation of future higher prices.
Inflation also allows debts to be paid off quickly with cheap dollars.
The Fed makes itself the whipping boy for a few years. Better yet, a fall guy appears, such as OPEC or, in the present case, all those foreigners turning in their dollar-denominated assets for cash in their own currency. Maybe that's why Greenspan decided to stay on, as penance for allowing the bubble to develop in the first place. Copyright 2000 Bankrate, Inc.