Simple Macro

I've been teaching the Macro part of 200 lately and I've used a post from Mankiw to illustrate a class example. Pretty simple stuff, but I think it describes what is happening to the economy today.

Uncertainty about the future has caused banks to stop lending and thus excess reserves have skyrocketed. This causes the money multiplier to fall creating a short run recession with deflation. The Fed is trying to counter the deflation by increasing the monetary base.

My prediction is that once banks get back to normal lending the money multiplier will rise. As a result, the money supply is going to rapidly increase due to all the money that the Fed put into the system. This will create an expansion and inflation. The Fed knows this is likely to happen and will try to counter it, but my guess is that they'll act too late and we'll still see significant inflation. By trying to stop the run-away inflation (which it created in the first place) the Fed will put the breaks on the economy causing some bubble that was created by the inflation to burst sending us into an other recession.

What should we look for to see if I'm right? The Fed will announce increases in the interest rate. Currently, the Fed's discount rate is around 1.75 (the lowest its been since November 2002; the end of the last recession). I predict that the Fed will raise rates up to around 5% or 6% within two years.

Not a very optimistic outlook, but I think its at least reasonable.