November 16, 2010

VOLCKER, REAGAN AND THATCHER SO THOROUGHLY VANQUISHED INFLATION...:

Can the Fed Offer a Reason to Cheer? (TYLER COWEN, 9/18/10, NY Times)

Here’s the problem: The economy needs help, but monetary policy, which is the Fed’s responsibility, has not been very expansionary. This is true even though the Fed has increased the monetary base enormously since the onset of the financial crisis.

How can this be? Supplying more money did not actually result in enough additional spending. The debilitating financial shock of the last few years convinced many consumers and businesses that they needed to save more. So they are holding on to much of the new money.

Given this problem, there is a logical and seemingly simple move available to the Fed: just make people believe that it is seriously committed to increasing the rate of inflation. Traditionally, the Fed has focused on restraining inflation, not stoking it. But these are unusual times.

If the Fed promises to keep increasing the money supply until prices rise by, say, 3 percent a year, people should eventually start spending. Otherwise, if they just held the money, it would be worth 3 percent less each year.

In a self-fulfilling prophecy, the Fed could stimulate spending and the economy, and at no cost to the Treasury. Of course, if no one believes the Fed’s commitment to price inflation, spending and employment will not go up. The plan will fail, and people will view their skepticism as vindicated.

In other words, one of our economic problems can be solved, but only if we are willing to believe it can. Ben S. Bernanke, the Fed chairman, wrote about this conundrum before he accepted his current job. In 1999, when discussing what the Japanese central bank could do about the country’s deep recession, Mr. Bernanke suggested “a target in the 3 to 4 percent range for inflation, to be maintained for a number of years,” saying that it would show the bank’s credible commitment to reflate the economy.


...that the threat is no longer credible.

Posted by Orrin Judd at November 16, 2010 3:18 PM
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