Happy now?

During the last 4 months of 2010 and early 2011 I got a lot of grief from the inflation hawks.  Yes, QE2 seems to have lowered unemployment from 9.8% to 8.8% in 4 months, but they were having to pay more at the pump (I assume these commenters had jobs.)  They warned that it was devaluing the dollar, leading to high inflation.

Unfortunately, in today’s world oil market with Chinese demand pushing production to near capacity, any recovery in the US (even an expected recovery) will push oil prices significantly higher.  And of course Libya was an additional bit of bad luck.  Payback for the good karma of the 1990s.

But this isn’t “inflation” in the 1970s sense.  Back then wages rose rapidly and every time you went out to buy a new car it cost almost twice the previous one.  This is an increase in the relative price of an important commodity, which strongly affects the headline CPI for a few months.  Even worse, our insane ethanol policies cause it to bleed over a bit into food prices.

Well now the inflation hawks have gotten their way.   Oil fell into the high 70s today.  The Fed did something completely trivial on Wednesday, and basically washed its hands of the responsibility to keep NGDP at an adequate level.  Both inflation and employment are now forecast to be far below the Fed’s implicit target over the next 5 years, and they don’t seem willing to do anything about it.  BTW, according to the Cleveland Fed the TIPS spreads I often point to actually slightly overstate expected inflation; they have a more complicated formula that I don’t understand very well.  It shows 10 year inflation expectations below 1.4%.  Five year expectations are even lower.

So that’s our choice.  Do we want to keep gas nice and cheap for those who have jobs, or do we want an economic recovery for the millions whose lives are being ruined by this recession.

And I’m not sure that even those with jobs benefit from these policies.  Every time I save a few pennies at the gas pump I lose many thousands of dollars off my retirement fund.  Economics is not a zero sum game.  When millions are producing no output, almost everyone will suffer.

HT:  Thanks to Lars Christensen for the Cleveland Fed data.


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62 Responses to “Happy now?”

  1. Gravatar of Benjamin Cole Benjamin Cole
    23. September 2011 at 08:41

    I was just about to comment on the Cleveland Fed release. Ouch.

    Where is the George Gilder who lectured conservatives that economic growth, freedom, innovation and prosperity were more important than a fetish for the fixed exchange rate or value of paper currency (excuse me, “fiat money” as the WSJ puts it).

    Our only salvation is that the GOP will forget all about monetary rectitude when they capture the White House.

  2. Gravatar of John Thacker John Thacker
    23. September 2011 at 09:00

    One thing to keep in mind, Scott and Benjamin– it’s not just conservatives. Take a look at this Hill poll, this Gallup poll, and this Rasmussen poll, all on inflation.

    They all say the same thing. Inflation is *not* a concern of only Republicans or conservatives. Independents and moderates are just as overwhelmingly concerned with inflation as Democrats. Democrats are less concerned with inflation, but still quite heavily concerned.

    That’s bad news, because it means that the concern over inflation and hard money is *not* the Republicans playing for their base. It’s actually a reach for the center. Being anti-inflation and warning of inflation is possibly the most popular policy choice politicians can make right now with the median voter.

    Yes, I think that the data shows that the public is wrong. Yes, it’s certainly true that doing the right thing monetarily and turning around the economy would make people happy and forget these concerns. But it’s simply not the case of crazy conservatives, or the GOP trying to sabotage things.

    As bad as that conspiracy theory would be, it would have an easier fix. But the reality is in practical ways even worse in a democracy.

    The GOP is mistaken for the same reasons that President Obama is mistaken about monetary and fiscal policy– but in the GOP’s case, they’re even listening to their experts, like John Taylor and others.

  3. Gravatar of John Thacker John Thacker
    23. September 2011 at 09:01

    Independents and moderates are just as overwhelmingly concerned with inflation as Democrats.

    Doh, wrote that exactly wrong. Independents and moderates are just as concerned as Republicans, and are unlike the less concerned-but-still concerned Democrats.

  4. Gravatar of Brito Brito
    23. September 2011 at 09:02

    Return of the Phillips curve?

  5. Gravatar of Meegs Meegs
    23. September 2011 at 09:02

    Thought experiment: if the FED adopts NGDP targeting, the economy recovers, and oil approaches $150 again like it did in ’07, how would 1) the economy be affected and 2)the American people react?

    On 1) I’m guessing the lower and middle classes would be hit harder, as a higher % of their income would go to paying at the pump. Oil companies would reap huge profits. There would be larger income disparity, but we wouldn’t be in a recession.

    On 2) there would be a severe backlash against whomever is in power at the time, and doves in the FED would probably be driven out/ not appointed, and we’d return to failed monetary policy.

    Until Americans understand the trade-offs involved, I am not optimistic about our current situation. It’s not enough anymore that economists understand that better monetary policy is needed.

  6. Gravatar of engineer27 engineer27
    23. September 2011 at 09:07

    Scott:

    Yglesias now admits you are totally correct:
    http://thinkprogress.org/yglesias/2011/09/23/327069/debtors-creditors-and-the-decline-of-the-producer-economy/

    “I now think Scott Sumner and David Beckworth have been right all along and we need to ditch talking about “inflation” in favor of something that means ‘nominal GDP.'”

  7. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. September 2011 at 09:07

    To be fair to the inflation hawks, it wasn’t a few pennies per gallon. It was $2-3 per gallon. If you drove a big pick-up or an SUV, pretty soon you were talking real money.

    Even worse if you were operating a business (construction) that needed diesel powered vehicles.

  8. Gravatar of Andrew Andrew
    23. September 2011 at 09:16

    Meegs & Patrick,

    Would you rather have the economy of June 2008 (Oil @ $150) or the economy of February 2009 (Oil @ $33)?

  9. Gravatar of Liberal Roman Liberal Roman
    23. September 2011 at 09:26

    For a long time I thought that popular opinion was what kept pressure on the Fed from doing what was actually necessary. Now, I don’t think that’s any longer the case. I mean there is a reason for why a central bank is independent.

    No, the reason for our stupid monetary policy is that our influential economists are sincerely stupid. I no longer believe in the “Morgan Theory” or the similar “Krugman Theory” that basically says that conservatives are acting dumb to worsen the economy

    I now believe Arnold Kling (http://econlog.econlib.org/archives/2011/09/my_thoughts_on.html). All those conservatives are genuinely and sincerely stupid. We are screwed fellas. We are really, genuinely, sincerely screwed.

  10. Gravatar of John John
    23. September 2011 at 09:27

    Scott,

    You think the economy won’t grow because monetary policy is broken. I’d argue that monetary policy is broken because the economy is bad. There is a low demand for loans and a lack of profitable business opportunities which causes banks to hoard reserves, stifling the Fed’s efforts.

    I blame the the debt overhang, which is a clear consequence of the government’s bailout everyone mentality, as the primary culprit behind the terrible business environment. Let the markets work, let bad investments liquidate, let bad companies go bankrupt, then you can have a solid recovery. This is gonna happen one way or another it’s just a question of how long it will take. Keep fighting the markets and expect to get beat.

  11. Gravatar of Benjamin Cole Benjamin Cole
    23. September 2011 at 09:30

    John Thacker–

    First, thanks for grouping me in with Scott Sumner, a much greater light in economics than I ever will be.

    Second, leaders lead. Did the public want to go into Iraqistan for 10 years and counting? We did anyway, as policymakers determined it was the right thing, and then sold the invasions to the public.

    We can’t sell the public on prosperity, growth innovation? I find that hard to believe.

    And John Taylor is an expert, but a fierce partisan first. Taylor regards GOP victory, and a heavily funded military-homeland security-VA as more more important than an early economic recovery.

  12. Gravatar of marcus nunes marcus nunes
    23. September 2011 at 09:30

    The last graph in this post indicates how “scary” the situation is, even before the last Fed show of (in)action!
    http://thefaintofheart.wordpress.com/2011/09/15/an-alternative-script-%E2%80%93-one-where-interest-rates-don%C2%B4t-make-an-%E2%80%9Cappearance%E2%80%9D/

  13. Gravatar of Meegs Meegs
    23. September 2011 at 09:35

    Andrew, obviously I would prefer the economy of June 2008.

    But what would the American people (and the politicians) prefer?

  14. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2011 at 09:47

    “Until Americans understand the trade-offs involved, I am not optimistic about our current situation.”

    YAWN. People are not dumb,

    Stop tacitly asserting your bias, instead lets throw it on the table, splay it open, gore it, and then rethink.

    PEOPLE KNOW we could be drilling deep and wide, building nuclear power plants in poor neighborhoods, increasing coal production, killing the EPA.

    And SINCE they KNOW it….

    They don’t want to print money and rive up the cost of gasoline.

    So INSTEAD, we should kill the liberal green bias, adopt a dirty coal miner bias, and when people are CONVINCED the liberals are not dragging us down with their goals….

    We can tell them we need to have looser money.

    Folks, I exist. Other people like me exist. And we’re going to get the world we want BEFORE we print money.

    So give up the stinking policy changes we want, and you’ll find a public far less concerned about the difference between your printing us from $1.50 gas to $3 gas…

    $5 gas is the issue. It means we haven’t punched enough hippies and we let the banker print money.

  15. Gravatar of John Thacker John Thacker
    23. September 2011 at 09:53

    Benjamin, the polls were much brighter on invading than they are on inflation.

    Sure, leaders can lead, but it’s a tough game expecting politicians to swim against public opinion. If it were so easy, then we would have free trade, open immigration, no minimum wage but a negative income tax, less zoning, no rent control, a consumption tax, and a host of other constitutive but approved by economist positions.

  16. Gravatar of Meegs Meegs
    23. September 2011 at 09:54

    OK Morgan,

    Americans understand the tradeoffs. But at this point, they are choosing 10% unemployment, cheap oil, and no additional drilling.

    Happy?

  17. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2011 at 10:04

    No.

    Obama is choosing 10% unemployment and no additional drilling.

    America is choosing to end Obama.

  18. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2011 at 10:06

    John Thacker,

    I think Public Employee Unions are against every one of those proposals.

  19. Gravatar of Meegs Meegs
    23. September 2011 at 10:08

    America chose Obama.

    And Americans have been choosing politicians who pursue anti-drilling policies for decades now.

    Not to mention, even if we drill all we want, that won’t be enough to bring the price of oil down.

  20. Gravatar of johnleemk johnleemk
    23. September 2011 at 10:16

    John,

    “Let the markets work, let bad investments liquidate, let bad companies go bankrupt, then you can have a solid recovery. This is gonna happen one way or another it’s just a question of how long it will take. Keep fighting the markets and expect to get beat.”

    A succinct explanation of Austrian/RBC theory. But by refusing to accommodate what the markets want, the Fed is stifling the market! In a free banking system, monetary policy (insofar as one can speak of monetary policy then as we might speak of food policy or IT policy today) would be much more accommodative than it is under the interventionist status quo.

    Under free banking, any issuer of currency which sterilised reserves the way Fed did with IOR would be toast. It’s precisely because we don’t have a free market that we need the Fed to get rid of IOR and credibly commit to supporting the NGDP growth rate which the market would otherwise provide.

  21. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. September 2011 at 11:08

    Here’s a pretty well written piece addressed to the political left:

    http://www.tnr.com/article/politics/95217/progressives-fed-monetary-policy

    ‘It is important that liberals engage conservatives on monetary debates. Since the 1970s, liberals have entirely ceded this aspect of the economic agenda. Even now, calls from the left for more monetary action gain only a fraction of the support of arguments for fiscal stimulus. But the left needs to realize that there is no neutral position in monetary policy””even if President Obama’s jobs plan is passed, its effects can easily be canceled out if the Federal Reserve caves to the singular pressure being applied to it by inflation hawks.

    ‘To whatever extent the Obama administration’s fiscal proposals might “Win the Future,” without taking monetary policy into consideration, they are unfortunately destined to lose the present. Because the present is a battle over low demand, high debt and people hoarding capital””three things that only a short period of sustained inflation will cure.’

    I’m guessing; ‘pearls before swine’.

  22. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. September 2011 at 11:21

    ‘Would you rather have the economy of June 2008 (Oil @ $150) or the economy of February 2009 (Oil @ $33)?’

    There’s a classic of the false dichotomy if I ever heard one. Didn’t the economy of 2008 lead to the economy of 2009.

    I can see the logic of Scott’s prescriptions (and just above I linked to a New Republic piece essentially parroting it), but I think it unlikely that Ben Bernanke and Paul Volcker are too stupid to understand. It very well may be that their judgment is wrong, but it’s not outrageous. It’s always a good idea to make the best case you can for your opponents’ position.

  23. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2011 at 11:27

    America chose Obama.

    100% correct.

    And like Clinton, Obama was invited to throw his all campaign goals under a bus, and end welfare as we know it, so that he could bring down the deficit, and get re-elected.

    Obama CHOSE incorrectly.

    Meegs, it only gets worse for you.

    At $3 a gallon, you have X support.
    At $3.50 you have less than X support.

    SINCE it is going to happen anyway, you should be making it your cause, pushing Obama to throw Al Gore under the bus, shrugging off the way you have to whore yourselves to to have 10% better than what the Repubs will do.

    Because at least you get that 10%!!!

  24. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2011 at 11:27

    “end public employee welfare as we know it”

  25. Gravatar of John John
    23. September 2011 at 11:54

    johnleemk,

    There’s no way to know what the markets want with the current system. I’m guessing that you’re arguing that an accomadative Fed policy announcement would drive up the stock and commodity markets. They’d also drive the prices down on the bond market, so which market do you think they should appease?

    But besides that, of course you could get markets to surge temporarily if you announced extreme inflationary policies as people attempted to protect their wealth from a falling dollar by getting into stocks/commodities. These policies might give you a quick economic jolt from sticky prices that Scott sees as the end goal of policy, but you can get a much bigger and longer lasting increase in production by serious deregulation and tax cuts/simplification. Increasing efficiency by slashing laws and taxation should be the number one goal of economists right now. That’ll give us real lasting benefits instead of more “hair of the dog” snake oil.

  26. Gravatar of Gabe Gabe
    23. September 2011 at 11:59

    Perry is a phony, lying, socialist. Morgan, Perry will do his best to keep growing the government(just like Bush did) and you are pretty naive if you believe otherwise.

    http://www.infowars.com/perry-caught-in-blatant-lie-over-support-for-bailouts/

  27. Gravatar of flow5 flow5
    23. September 2011 at 12:15

    It’s time to fire Bernanke.

  28. Gravatar of John John
    23. September 2011 at 12:17

    I actually think the debate between liberals and conservatives is miss-named right now. You have the anti-stimulus side and the pro-stimulus side. The anti-stimulus side is mostly right wing and the pro-stimulus side is mostly left wing with some exceptions such as the monetarists. But in my mind all the pro-stimulus people are big government guys on the wrong side of history just like Mao (I don’t really think they’re mass murderers though).

  29. Gravatar of John John
    23. September 2011 at 12:25

    Scott,

    I’m dying to know how monetary policy can work without a strong demand for loans. If you can answer that one well, I’ll be converted to your view point and stop bugging you.

  30. Gravatar of CA CA
    23. September 2011 at 12:36

    John, this is from the FAQ’s section:

    6. But what if banks cannot find good credit-worthy borrowers?

    Then they can use the excess reserves to buy Treasury bonds. This will put the cash into circulation, and boost aggregate demand through the “excess cash balance mechanism.”

  31. Gravatar of Steve Steve
    23. September 2011 at 12:59

    John wrote:

    “I’m dying to know how monetary policy can work without a strong demand for loans. If you can answer that one well, I’ll be converted to your view point and stop bugging you.”

    Higher NGDP expectations create demand for loans.

  32. Gravatar of Matt Waters Matt Waters
    23. September 2011 at 13:01

    If high QE and negative IOER don’t go to investment, then the new money would all go into either Treasury bonds or into physical cash or gold holdings in vaults.

    Long-term Treasury bonds, however, have interest rate risk, which is why long-term bonds are not yielding zero. Holding literal cash or gold in vaults is also expensive and there is a big risk that gold could go down in dollar value substantially. All other physical commodities are too expensive as a store of value, such as oil or silver.

    That means that, contrary to Krugman, QE has only been ineffective because banks can earn 0.25% to not lend out the newly printed money. When the government pays banks, and consequently depositors, to not lend out the new money, then QE indeed becomes less effective.

    Then, if investors truly cannot find somewhere to invest their money, they could spend it, donate it to charity, whatever. Are there really charities out there who would not spend money if given it?

    It’s not up to the Fed to decide whether Treasury holders will spend or invest their money they get from the Fed. The free market will determine whether the current Treasury holders spend or invest the new money. The Fed, however, can target the combination of spending and investing (i.e. NGDP) by doing QE and negative IOER until it recovers and so far they’ve refused.

  33. Gravatar of Lars Christensen Lars Christensen
    23. September 2011 at 13:03

    Scott, here is a simple rule. How about the FOMC announced that it would buy 100bn worth of T-bills in the beginning of every month if the Cleveland fed 5-year inflation expectation is below 2%. One month later if it is still below 2% they step up the buying to 200bn. Every month the Fed doubles the buying until inflation expectations hit 2%. Once inflation expectations hit 2% the Fed suspend the buying of T-bill. This is not exactly NGDP targeting, but in my view this would ensure a very swift recovery in the US economy and I have a hard time seeing how the Republicans could be against such a clear inflation target. I think our friend John Taylor would have to endorse it as well.

    I think the Cleveland inflation expectations numbers provides an excellent guide for monetary policy – the Fed should use the tools developed by their our analysts.

  34. Gravatar of John John
    23. September 2011 at 13:16

    Steve,

    In this case the excess cash balance mechanism sounds like a circular argument. I’m arguing that banks aren’t making additional loans because of a lack of good investment opportunities and the excess cash balance mechanism argues that the investments will automatically happen firms get tired of holding the extra cash. Is there some magical tipping point where banks start giving money to anyone with a pulse in the hope that this will earn them a better return than holding money? And if so, is this a good thing? If they push money into treasuries, it may lower the borrowing costs for the government, giving them an excuse to spend, but most people on this sight know that fiscal stimulus can be pretty ineffectual.

  35. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2011 at 13:46

    Gabe,

    I’m a giant supporter of Perry. And I do so with my eyes WIDE OPEN.

    There’s a slew of politician in Perry. I’ve written that Tea Party folks aren’t being honest when they say Romney will automatically government like he’s from a Blue State. RINO isn’t true. Politicians CHANGE in the wind.

    (You could give me anyone but Santorum, and I’ll love them – even Bachamn if forced.)

    Gingrich, who would be the best thing for America, just doesn’t seem electable to me in the Primary.

    In my mind, between Perry and Romney, I think when Perry thinks about Republicans, the ones he truly identifies with are the SMB guys, not the Wall Street guys. Romeny it is just the opposite.

    And in my mind, the only way we will truly capitalize on 2012, is if SMBs get to take a giant bite out of the ass of Fortune 1000, so Romney really is a consolation prize.

    I don’t think Perry considers himself a genius, I think he’s truly humbled by the day to day accomplishments of nuts and bolts entrepreneurs.

    I agree with Perry on Immigration and on Social Security, I think most thinking conservatives do.

    Finally, I’m afraid Romney won’t repeal Obamacare. I THINK he will, but its a risk impact thing… small risk / GIANT impact.

  36. Gravatar of Benjamin Cole Benjamin Cole
    23. September 2011 at 13:56

    John Thacker-

    You make good points, but I think prosperity trumps all. If we are running 4 percent unemployed, and real and equities are up, the public will be happy, even at 5 percent inflation.

    This time around the fearmongers and gold nuts were braying about inflation, and GOP’ers loved it. Listen, Taylor wants Obama out at nearly any cost (and Taylor has steady income in the meantime—-he can afford some ugliness that many others cannot).

    I tell you I would tolerate moderate inflation happily for some real boom-times.

  37. Gravatar of Matt Waters Matt Waters
    23. September 2011 at 14:18

    “Taylor has steady income in the meantime”

    My biggest issue with the Very Serious People. Just about all of them are either tenured at Universities, have substantial assets or somehow economically secure. That goes not just for economics professors, but CEO’s and politicians.

    The dynamic is similar to Caplan’s explanation of irrational voters. The same voters are generally rational with their own money, but then make irrational choices at the ballot box. In the latter case, there is very little direct repercussions to their beliefs.

    That dynamic is especially acute for those such as Taylor, Volker, Perry, Ron Paul, various CEO’s, etc. When it does not matter for them to have beliefs directly contradicted by the data, they will hold fast to whatever beliefs get them the most attention, not the beliefs that are actually correct.

  38. Gravatar of John John
    23. September 2011 at 14:37

    Steve,

    I got confused between answering you and CA. This one is actually for you. My critique is the same. Your saying that rising NGDP expectations would boost the demand for loans when I’m saying that there is no way to boost NGDP expectations without a boosted demand for loans.

  39. Gravatar of Benjamin Cole Benjamin Cole
    23. September 2011 at 14:59

    Matt Waters-

    I run a small furniture-making business and do some PR for architects on the side. Every bump in the economy is like a streak of lightening landing near the nest, as far as I am concerned. Business is way down and ugly.

    And yet, I am lucky. There are guys just flat-out unemployed.

    And you are right: Arguments about whether a percent of two of inflation is to too much to endure might be fine for cosseted talking heads and the economics policy journals, but I can tell you I think people have marbles in their heads if they chose low inflation rates before prosperity.

    Crickey-almighty, the purpose of an economy is prosperity, not price stability.

  40. Gravatar of StatsGuy StatsGuy
    23. September 2011 at 15:59

    They’re still not happy… Also, it’s not so much about west texas crude as Brent these days. They want Brent under 90 for a while, to give them room to run. I finally caught your post on oil earlier, added a comment –

    https://www.themoneyillusion.com/?p=10954#comment-84652

    Sorry, been traveling. The Fed is, however, probably pleasantly upbeat about the drubbing that Gold took today (no, I’m not short gold). They got it back to 1650 faster than they’d expected.

    Matt –

    “Crickey-almighty, the purpose of an economy is prosperity, not price stability.”

    Amen.

  41. Gravatar of David Pearson David Pearson
    23. September 2011 at 16:09

    Scott,

    For the record, Brent crude closed at $107 today. It was around $65 before Bernanke’s 2010 Jackson Hole speech. Brent is the benchmark crude for global gasoline refiners.

    Inflation expectations are indeed headed down, but crude prices are hardly the place where “inflation hawks have gotten their way.”

  42. Gravatar of David Pearson David Pearson
    23. September 2011 at 16:10

    Typo above: that should have read “It was around $75 before…”

  43. Gravatar of flow5 flow5
    23. September 2011 at 17:36

    The FED should monetizze governments (from the non-bank public sector), in order to increase aggregate monetary purchasing power. Historically, all injections of liquidity (given a low inflationary environment), initially stimulates real-gDp at a faster rate than it does prices.

    Second on the list would be to get the CBs out of the savings business. In today’s terms, that means gradually reducing the remuneration rate (contrary to Friedman, Volcker, & Bernanke), & or simultaneously re-introducing new reserve requirements (contrary to everybody). If private profit institutions are to be allowed the “sovereign right” to create money, they must be severely regulated in the management of both their assets & their liabilities.

  44. Gravatar of Scott Sumner Scott Sumner
    23. September 2011 at 17:38

    Ben, I’m sure they’ll immediately start calling for easy money.

    John Thacker, That’s why I keep arguing that so-called “public opinion” is meaningless. Very few people even understand what inflation is. They make no distinction between supply and demand side inflation. When LBJ left office we had 5% inflation and 4% unemployment. If we have that sort of demand side inflation today Obama would be hugely popular. People mostly think in terms of supply-side inflation (they hold their incomes constant.) I’m talking about policies to boost the INCOMES of Americans. That would be very popular.

    Brito, No question there is a return of the PC. 9% unemployment and 1% inflation over the past three years. That’s the PC.

    Meegs, I can’t speak for everyone, but as far as I recall people were much happier about the economy when oil was $147. Obama has become hugely unpopular, and it certainly isn’t due to 1% inflation over the past three years.

    Engineer27, Yes, I saw that.

    Patrick, Fair enough, but I was referring to the effects of QE2, which was a few pennies, or perhaps dimes. Certainly far less than a dollar.

    Liberal Roman, Good point.

    John, The Fed is definitely facing headwinds, but they are perfectly capable of overcoming them. Does any commenter think I couldn’t create inflation if put in charge of the Fed?

    Marcus, Yes, and now it’s even worse.

    Patrick, That’s a good one. BTW, I was just interviewed by TNR.

    John, Thanks for saying I’m not a mass murderer like Mao, but isn’t calling me a big government guy almost as bad?

    Monetary policy can “work” in a world where banks and loans don’t exist. It’s called the hot potato effect. Put enough cash out there and people will eventually try to get rid of it. That drives up demand for goods services and assets, boosting AD and NGDP. It’s all based on the fallacy of composition–individuals can get rid of cash but society as a whole can’t, except through inflation.

    Matt, Good post.

    Lars, Not a bad idea.

    Statsguy, If they are happy about gold amid all this carnage, they are even more removed from reality than I feared.

    David, I didn’t know the gap had gotten that large, but does WTC have zero impact on gasoline prices?
    Don’t forget only a fraction of that price rise was QE2, other factors like China and India and Libya also played a role. The dollar didn’t depreciate very much, and US demand did rise much, those are the two mechanism for QE2.

  45. Gravatar of John John
    23. September 2011 at 17:45

    Excess reserves have gone from less than 100 billion to over 2 trillion. What number does it take to get this hot potato effect and is it even a good thing if banks start lending to anyone with a pulse? Why not stimulate the demand for loans by slashing regulation and cutting wasteful spending. Liberate the economy from the “deadening hand of government” as Friedman put it and the problem will fix itself. Not only would that work better, but it would give us a freer society in the long run.

  46. Gravatar of MikeDC MikeDC
    23. September 2011 at 18:04

    Ben Cole,
    I hear what you’re saying, but you also can’t take it as an article of faith that you 5% inflation will get you 4% unemployment.

    Throw out the fancy math for a minute and just think about it this way: do you really think a cost of an extra 2% additional inflation is all that’s holding us back from a gain of 5% points knocked off unemployment?

    Suppose we get that 5% inflation in all your costs? Do you feel confident right now that you can raise your prices to compensate without losing an assload of business?

  47. Gravatar of pct pct
    23. September 2011 at 18:36

    Regarding John Thacker’s point, can anyone suggest a good reason why the Fed does not cut IOR? I doubt that the average person has any idea that reserves exist, much less that the Fed is paying interest on them. An announcement that IOR was being cut from 25 bp to 10 bp would sound like an insignificant technical change compared to buying 400B in long term bonds, and would slide under the radar. (It could even be given a populist framing — “We’re sticking it to the greedy Wall Street types.”)

    The only reason I can come with off hand is that banks depend on it for income, which is scary this long after the fall of Lehman.

  48. Gravatar of mbk mbk
    23. September 2011 at 19:57

    Off topic – Thinking like an economist on gas prices:

    http://xkcd.org/951/

    (also hover over the comic for additional subtext)

  49. Gravatar of Steve Steve
    23. September 2011 at 20:16

    John wrote:

    “Steve, I got confused between answering you and CA. This one is actually for you. My critique is the same. Your saying that rising NGDP expectations would boost the demand for loans when I’m saying that there is no way to boost NGDP expectations without a boosted demand for loans.”

    John,

    If the Fed told me that NGDP would be AT LEAST 25 percent higher in 5 years, I would go out and buy several houses using 15 year 3.5% mortgages. There would be no way to lose. Plus I’d consume stuff along the way and businesses would borrow and invest more to meet my demand. That is NGDP expectations causing high loan demand.

    Right now, the Fed is intent on moving in the other direction. They’d read what I wrote above and say it is moral hazard and most be punished. Or that a five year commitment is unbecoming of a central banker because monetary policy should be dependent on the conditions (and politics) of the moment. Therefore, I’d rather sit on my hands, buy 10-year treasuries at 1.5% and wait for the world to end.

  50. Gravatar of Steve Steve
    23. September 2011 at 20:40

    Scott Sumner wrote: “Do we want to keep gas nice and cheap for those who have jobs, or do we want an economic recovery for the millions whose lives are being ruined by this recession.

    And I’m not sure that even those with jobs benefit from these policies. Every time I save a few pennies at the gas pump I lose many thousands of dollars off my retirement fund. Economics is not a zero sum game.”

    Scott, this is a very important point. I’ve spent so much time studying energy and other commodity prices that I have way more to say on this topic than I could possibly post in your comment section. I’m looking into starting my own blog to do this.

    One upshot of my work is that oil is probably going to be centered around $75 to $90 long-term no matter what the monetary policy. Microeconomics still matters. There is a short-term response: higher employment equals more commuting, more vacation travel, and more goods shipped. This means higher short-term oil. But production and efficiency cancel this out over the medium term. The reverse is also true. So the “victory” of lower prices is pyrrhic. You just will just get another price spike off a lower output base later.

    Obviously you don’t want oil to go up beyond reason as the economy needs time to make the medium term adjustments. That’s the structural argument. So you don’t want unreasonably large short-term stimulus. But you need enough sustained strength so that businesses can make investment decisions on microeconomic merit rather than on a macro crapshoot. How do you ensure the price spikes (and crashes) stay bounded so that the right signals get sent? NGDP level targeting is superior to any other option I’ve seen. It’s vastly superior to the bs that our central bank is pulling.

  51. Gravatar of Rien Huizer Rien Huizer
    23. September 2011 at 21:15

    Scott,

    I experienced the early 1970s on a trading desk and the one thing that I learned from that period (a seemingly inexorable rise in the employment share and associated decline in industry profitability, and explosion of stupid cross border lending to recycle petrodollars, enormous commodity price volatility). That inexorable rise was caused by labor market inefficiency and accommodated by monetary policy in a basically closed economy (you may change the causation of course). No one at that time foresaw that in the following years there would be a monetary policy that would hit those impoverished businesses with very high real interest rates and that Japanese firms would outgrow their cheap and nasty image very quickly at the same time. And then we got the opening of China, the full impact of the information revolution combined with a transportation revolution, and bingo, no more labor blackmail, no more Japanese low cost competition and again, prosperity (or moderation) forever, just like in parts of the 1960s. And that party ended a few years ago. Forever? Or maybe just for a couple of years, a decade, or perhaps a generation?

    Who says there is not something around the corner that will make all of us look foolish a few years down the road? What could it be? The thing about this history is that none of the changes were the result of innovative thinking by economists or politicians. They merely sang along, usually out of tune. So maybe we are at one of those points where people start to panic themselves in some solution that happens to appeal to people that happen to be in a position to implement it. It could be level targeting, but to me, that lacks drama. Maybe next year the political process will throw up someone truly controversial and ridiculed by the literates. Now, that kind of person could give a jolt to the pinball machine that we live in. Like Reagan. Forget Romney or even Perry, or even someone from Alaska. Someone with great communicative skills. A Pastor perhaps?

  52. Gravatar of Rien Huizer Rien Huizer
    23. September 2011 at 21:21

    Scott,

    You wrote

    “John, The Fed is definitely facing headwinds, but they are perfectly capable of overcoming them. Does any commenter think I couldn’t create inflation if put in charge of the Fed?”

    Are you kidding? If you could, they would have put you there..

  53. Gravatar of Peter Peter
    23. September 2011 at 23:39

    June 2015. Scott Sumner’s opening speech as the new dictator of the Federal Reserve.

    “We have behind us an ordeal of the most grievous kind. We have behind us many, many long months of struggle and of suffering. You ask, what is our policy? I will say: It is to get nominal GDP back to its historical growth path, with all our might and with all the strength that a printing press can give us; to wage war against a monstrous unemployment never surpassed in the dark, lamentable catalogue of human history. That is our policy. You ask, what is our aim? I can answer in one word: It is victory, victory at all costs, victory in spite of all terror, victory, however long and hard the road may be.

    We shall use the printing press to no end. We shall buy up every single treasury, we shall buy up all arable and non-arable land, we shall buy more and more private debt, we shall defend our GDP, whatever the cost may be. We shall buy up all publicly traded companies, we shall buy up all foreign currencies, we shall buy up all the gold and the silver, we shall buy up all financial assets; we shall never surrender!”

    Apologies to Churchill, for abusing his great speech.

    But no, even that wouldn’t be enough. Because the banks would just sit on all that extra money. We obviously need more shovel-ready projects since monetary policy doesn’t work in a liquidity trap. Let’s ask Gary Johnson’s neighbor’s dogs for help.

  54. Gravatar of dwb dwb
    24. September 2011 at 06:16

    keep in mind China is a huge consumer of commodities, has a big inflation problem, and the Yuan FX market is not a free market. American exports are a lone bright spot – and big export item is food.

    consequently, monetary stimulus that helps drive down unemployment is likely to be associated with higher food and energy prices.

    Yes this causes pain. In these times you have to ask what kind of pain you prefer (lack of pain is not a choice). Higher food and energy prices? or massive unemployment?

    Just one person’s opinion but the focus on oil is misguided. While it causes pain at the pump, oil is an expensive resource. Regardless of environmental regs, it still costs a lot of money to drill offshore miles below the ocean. The cold hard laws of substitution say that the only way to encourage energy efficiency and promote substitutes is, um, to make it expensive. oil is going to be more expensive when the output gap is closed, as it will be more scarce. . So… to me commodities inflation is not proof of failure. its proof of success! We have a huge output gap… so any policy that does not create some short to medium term commodities “inflation” is not working!

    In the short to medium term, food and energy go up, but will not do so indefinitely. High prices promote a supply response and investment… which ultimately means jobs.

  55. Gravatar of dwb dwb
    24. September 2011 at 07:02

    ok I just want to add a corrollary about high food prices – Americans, as a rule, do not spend a lot of their budget on food and already are considered obese. I can buy 3500 calories at burger king for under $3.00 (that is about 2x the daily dietary needs of an adult). Or, i can buy hormone-free organically raised blah blah for 4x the price. my choice. The former also comes with a lot of long term health care costs, by the way. point is, higher food prices will encourage efficiency in that area as well (lower consumption per person). So higher food prices means we are exporting more and eating less as Americans. oh, the pain!

  56. Gravatar of This isn’t “inflation” in the 1970s sense « Economics Info This isn’t “inflation” in the 1970s sense « Economics Info
    24. September 2011 at 08:02

    […] Source […]

  57. Gravatar of John John
    24. September 2011 at 21:22

    In response to Steve and Scott,

    If you wanted to create inflation or boost NGDP reserves like your talking about, I think you might find that it is harder than you think when your actually in the driver’s seat. Without a demand for loans, there is no mechanism to transmit money through the economy besides the excess cash balance mechanism. The excess cash balance mechanism hasn’t worked so far despite incredible growth in the monetary base, the monetary aggregate the Fed has control over. Do you really think another trillion or two will do the trick?

  58. Gravatar of mbk mbk
    25. September 2011 at 04:09

    It is amusing to read the financial comments in recent days, as always. Here in Singapore, papers attributed the surge in the USD and the fall in Asian currencies (incl. the Singapore Dollar, down 8% on the USD in a week), to a “flight to the safety of US Treasuries” (sic) because somehow it apparently dawned on investors, all of a sudden, that Asia is not decoupled from the West and that investors therefore flee Asia for the US. Totally unconvincing, like most ad hoc / post hoc financial commentary usually anyway.

    I’d have to say here Scott you are pretty darn convincing on the whole tight money thing, one can almost see the hydraulic equilibrium being re-made after some move affecting the various liquidities.

  59. Gravatar of Scott Sumner Scott Sumner
    26. September 2011 at 05:36

    John, I can see you are new to my blog.

    1. The ERs now pay interest.

    2. The increase needs to be permanent to have an effect, which is why an explicit target is so important. The Fed refuses to make that commitment, so of course it doesn’t work. I explained why temporary OMOs don’t work in a paper published in 1993.

    Mike, You said;

    “Throw out the fancy math for a minute and just think about it this way: do you really think a cost of an extra 2% additional inflation is all that’s holding us back from a gain of 5% points knocked off unemployment?”

    No I think an addition 3%, the natural rate is about 6% because of structural problems. But I’d favor NGDP targeting even if it didn’t create one job.

    mbk, Thanks for the link.

    Steve, I agree, but I wouldn’t be surprised if the price range was even higher.

    Rien, Even Bernanke says he can create inflation and NGDP growth whenever he feels like it. He just prefers not to. So there is no need for me, they already have a skilled pilot.

    I agree politics is unpredictable.

    Peter, Let’s see them sit on it with a negative 3% IOR.

    dwb, Good point.

    John, The Fed has not tried to boost inflation above current levels–listen to what they say.

    Thanks mbk.

  60. Gravatar of Peter Peter
    26. September 2011 at 06:28

    Scott, I was just kidding with my last paragraph (not sure if you got my sarcasm). I can’t understand how anyone could doubt that you being made dictator of the Fed and making a speech like that and then implementing that ‘buy-all’ strategy would not increase NGDP.

  61. Gravatar of Scott Sumner Scott Sumner
    28. September 2011 at 14:58

    Peter, Thanks, I read so many sometimes the nuance goes over my head.

  62. Gravatar of A misbegotten Union – Guest post by Lorenzo « Skepticlawyer A misbegotten Union – Guest post by Lorenzo « Skepticlawyer
    5. October 2011 at 14:07

    […] transactions, pushing the US economy well below its trend growth path. Yet people babble on about inflationary risks, just like the 1930s. (Alas, much of the economics profession seems clueless, the key central banks […]

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