September 21, 2014


Stuck on Inflation (Jeff Madrick, 9/16/14, NY Review of Books)

It is far too early to start tightening policy, but to these three Fed presidents, who help set Fed policy, it is never soon enough. The three bankers do not always sit on the Fed's Open Market Committee, where Fed policy decisions are made, but they are vocal about their hawkish views, and their comments have had wide reverberations in public debate.

It's instructive, therefore, to examine what they were saying back in 2008, the year the economy slid into the worst recession since the Great Depression. The Fed did not cut interest rates that summer and failed to help save Lehman Brothers that September, in part due to over-optimism about the economy. By the fourth quarter of 2008, the nation's Gross Domestic Product was falling at an annual rate of more than six percent. Consumer inflation was negative.

At the time, rising inflation should have been the last thing on anyone's mind. But what were the inflation hawks saying during those calamitous months? Along with the seven governors of the Fed and a few other bank presidents, Fisher, Lacker, and Bullard participated in many of the Fed's Open Market Committee meetings that year--the meetings at which decisions about interest rates and other policies, such as quantitative easing, are made. The complete minutes of the committee's 2008 meetings were released earlier this year.

Let's begin with Fisher, who this July said, "I believe we are at risk of doing what the Fed has too often done: overstaying our welcome by staying too loose too long"--in other words, apparently, we should raise interest rates as soon as possible.

Here are a few comments Fisher made at an Open Market Committee meeting in the summer of 2008 as the economy was collapsing:

The real bad news is that our patient appears to be acquiring a staph infection in this hospital that we have created, and that staph infection is inflation. I believe inflation is upon us. I believe expectations are discounting more inflation. Very importantly --and this is tough to get from the models--I believe that behavioral changes are beginning to manifest themselves. Now, some would argue that this infection is temporary and may well go away. Others will argue that it will be stayed by strong rhetoric. Still others say that it will require --I don't know if it's an antibiotic or an antidote--further tightening, lest the infection spread and counteract the good that we have done.

Fisher voted to raise interest rates in the summer of 2008, as the economy was plunging. He said at a meeting, "I think it is important to take a shot across the bow" to halt inflation. "I think we have to put some substance behind our words."

Many economists have noted that employment is too weak these days to suggest there are inflation pressures. Wages in particular have not risen. To the contrary, they're down several percentage points after inflation from mid-2009, when the recession technically ended. In a recovery, they should rise sharply.

But in the summer of 2008, Lacker criticized just such thinking as a failure to see signs of inflation ahead.

It is popular, as many have noted around the table, to cite the stability of compensation gains as evidence that we are not seeing a wage-price spiral. I have done it myself recently. But I share the concerns expressed [by some others] around the table about that being a lagging indicator. I am concerned that, if we wait until we see rising inflation expectations showing up as wage pressures, we will have waited too long. I noted in just a casual glance at the data from the 1970s that, although wage acceleration was a prominent component of the acceleration of inflation in the late 1960s, it was largely absent in the accelerations that occurred in '74 and '79.

Lacker doesn't believe that the failure of wages to rise suggests inflation is not a threat. Wrong then, and probably wrong now.

As for James Bullard, he calls himself the "North Pole of inflation hawks," according to an interview in Bloomberg News. In July of this year he too warned that inflation is coming back. Any unemployment rate below 6 percent will stimulate it, he believes. For him 6 percent is simply full employment. This is despite the fact that the unemployment rate fell below 4 percent in the late 1990s and inflation stayed low.

The liberation of productivity from labor is not reversible.
Posted by at September 21, 2014 7:34 AM

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