Since 2008, the Federal Reserve has been trying to stave off economic disaster with an unconventional monetary policy tool known as quantitative easing. By buying financial assets from commercial banks and other institutions, the Fed has massively expanded the money supply-quadrupling it since the practice began.
Many economists, particularly followers of the Austrian school, deplored the practice and predicted that the unprecedented currency and asset price manipulation would lead to huge and damaging price inflation. reason was among them, declaring on our October 2009 cover: "Inflation Returns!" A group of free market economists were asked: "Has the time come to stockpile canned goods and pick up a wheelbarrow for transporting currency, or should we be afraid of the opposite-a prolonged contraction that causes prices to crash?"
Six years later, official consumer price index inflation sits at just 2 percent annually from July 2013 to July 2014, the latest period for which figures are available. This is identical to the rate for the previous year.
We asked four economists and market analysts to revisit what they originally predicted would happen after quantitative easing and assess whether (and why) they were right. Analyst Peter Schiff sticks to his guns, saying that any "claims of victory over inflation are premature and inaccurate. Inflation is easy to see in our current economy, if you make a genuine attempt to measure it." Economist Robert Murphy believes we are in a "calm before the storm" and is "confident that a day of price inflation reckoning looms." Contributing Editor David R. Henderson writes that the "financial crisis has brought such major changes in central banking that uncontrolled inflation from discretionary monetary policy is not as great a danger as it once was," though he remains critical of the Fed's growing powers. And economist Scott Sumner claims victory for the "market monetarists," noting that both Austrians and Keynesians have been proven wrong by events, and urging both sides to "take markets seriously."—Brian Doherty
Where Is the Inflation?
Peter Schiff
Back in 2009, when the federal government began running trillion-dollar-plus annual deficits and the Federal Reserve started printing trillions of dollars to buy Treasury debt and subprime mortgages, economists debated whether much higher inflation was inevitable. Mainstream economists (who hold sway in government, the corporate world, and academia) argued that as long as the labor market remained slack, inflation would not catch fire. My fellow Austrian economists and I loudly voiced the minority viewpoint that money printing is always inflationary—in fact, that it is the very definition of inflation.
Today, with price inflation still not rampant, it's hard to ignore the victory chants coming from the White House press room, the minutes of the Federal Reserve's Open Markets Committee, the talking heads on financial television, and the editorial pages of The New York Times. They claim that the Fed's extraordinary monetary policy and the government's fiscal stimulus have succeeded in keeping the economy afloat through the Great Recession without sparking inflation in the slightest. Deflation, they argue, is still the bigger threat. Their claims of victory are premature and inaccurate. Inflation is easy to see in our current economy, if you make a genuine attempt to measure it.
The Consumer Price Index (CPI) doesn't qualify as a genuine attempt to measure inflation. The CPI report for July 2014 came in at 2.0 percent year-over-year. But because of consistent alterations in how the data is calculated, the CPI has hidden price increases under a blanket of subjective "adjustments." While the details are intricate, the results can be glaring.
For instance, between 1986 and 2003, the CPI rose by 68 percent (about 4 percent per year). Over that 17-year period, the "Big Mac Index," a data set compiled by The Economist that tracks the cost of the signature McDonald's burger, rose at a nearly identical pace. Since then, this correlation appears to have broken. Between 2003 and 2013, the Big Mac Index rose more than twice as fast as the CPI (61 percent vs. 25 percent). The sandwich, which reflects the average person's direct experience, may be a more accurate yardstick of inflation.
Meanwhile, the Fed is pushing up prices not reflected in the CPI. Through its zero-interest-rate policy and direct asset purchases via quantitative easing, the Fed has lowered the cost of capital and raised prices for stocks, bonds, and real estate. In doing so, it has argued that rising asset prices create a "wealth effect" and are thus a key goal of its monetary policy.
Over the past five years, the prices of these financial assets have risen dramatically. However, unlike past periods of bull asset markets, these increases have not been accompanied by robust economic growth. To the contrary, the last five years have seen the slowest non-recession economic growth since the Great Depression.
This Fed-driven dynamic explains the rich-get-richer economy we've seen since the alleged recovery of 2009 began. The wealth effect has allowed the elites to push up prices for high-end consumer goods such as luxury real estate, fine art, wine, and collectible cars. But that is cold comfort to rank-and-file Americans struggling to find work in an otherwise stagnant economy.
Broader consumer price inflation has been kept at bay because many of the newly printed dollars don't even hit our economy. Instead, foreign countries purchase them in an attempt to keep their own currencies from appreciating against the dollar. In the current environment, a weak currency is widely (and wrongly) seen as essential to economic growth. That's because a weak currency lowers the relative price of a particular country's manufactured goods on overseas markets. Nations hope those lower prices will lead to greater exports and more domestic jobs.
Thus we see "currency wars," in which the victors are those who most successfully debase their currencies. That policy perpetuates greater global imbalances (between those nations that borrow and those nations that lend) and the accumulation of dollar-based assets in the accounts of foreign central banks.
The more debt the U.S. government issues, the more purchases these foreign banks must make to keep their currencies from becoming more valuable relative to ours. It is no coincidence that many of the countries heavily buying U.S. dollars, such as China, the Philippines, and Indonesia, are experiencing high levels of domestic inflation. Inflation may now be America's leading export.
In recent years, U.S. federal deficits have declined from more than $1.2 trillion to less than $600 billion. This is not because the government has made hard choices to raise revenue or cut spending but because rising asset prices have resulted in greater tax receipts from the wealthy. Yet this windfall can only last until the next meaningful correction in asset prices. If tax revenues fall, growing federal deficits would compel the Fed to print the difference. In that case, foreign banks would need to buy even more dollars to maintain their currency valuations. If they lose the will to keep pace, the dollar would lose relative value. A weaker dollar could be the spark that finally ignites significant CPI inflation in the United States.
As foreign currencies gain strength, consumers in those countries will gain buying power and more finished products will gravitate toward foreign shelves. Given that a significant portion of the products we now buy are imported, the diminished domestic supply could push up prices for common products like apparel, electronics, and appliances.
The Fed used to be considered effective when it kept inflation low. Today, inflation is the goal. This is especially true for the Federal Reserve as led by Janet Yellen, who looks set to be the most dovish-on-inflation chairperson in the bank's history. The inflation created by the U.S. government has been delayed, not avoided. Already the costs of everyday goods are rising faster than incomes. This is why economic pessimism is so prevalent on Main Street. Sadly, that gap is likely to get much worse.
Mainstream economists would have us believe that inflation and a weak labor market can't exist simultaneously. Have they ever been to Argentina? Do none of them remember the stagflation of the 1970s?
The truth is that high levels of unemployment are historically correlated with higher inflation and low levels of unemployment with lower inflation. That is because an economy that more fully utilizes labor resources is more productive. More production brings down prices. In contrast, an economy that does not fully employ its citizens is less productive, and its government is more prone to pursue misguided inflationary policies to stimulate the economy.
Although America's policies may not differ dramatically from what has been disastrously tried by Argentina, the dollar is for now protected by the international reserve status that it has enjoyed for almost 70 years. But that privilege has its limits. The dollar may be bigger and more globally integrated than any other paper currency, but in the end, its value may be just as ephemeral.
Peter Schiff is CEO of Euro Pacific Capital and author of The Real Crash: America's Coming Bankruptcy (St. Martin's).
The Calm Before the Storm
Robert Murphy
Since the fall of 2008, I have been among the economists, many from the Austrian tradition, warning the public about the disastrous policies enacted by the Federal Reserve in response to the financial crisis. The Fed was generating unprecedented increases in the monetary base, which is the quantity of dollars held by the public as currency and held as reserves by commercial banks. In late 2009, I made a public wager with economist David R. Henderson in which I predicted a 10 percent year-over-year increase in the Consumer Price Index by January 2013. I lost that bet. In general, warnings about price inflation seem to have been premature at best, totally wrong at worst.
It's true that consumer prices did not zoom up as I had predicted, but my objection to the Fed's post-crisis policies was never dependent on that specific forecast. Indeed, the distinctive feature of Austrian business cycle theory is that "easy money" causes the familiar boom-bust cycle by affecting relative prices. Regardless of the purchasing power of the dollar, the Fed's actions have definitely interfered with interest rates, hindering the communication of information about the condition of the credit markets. By postponing needed readjustments in the structure of production, the Fed's actions have allowed the problems apparent in the fall of 2008 to fester.
I am still confident that a day of price inflation reckoning looms and that the U.S. dollar's days as the world's reserve currency are numbered, though I have no way of gauging the duration of this calm before the storm. Still, my 2009 predictions about consumer price inflation were wrong, and it's useful to analyze why.
At the time, I thought the Fed's policies were simply going to kick the can down the road and exacerbate the underlying structural imbalances in the economy. The housing bubble had itself been fueled by the artificial monetary stimulus and rate cuts under previous Fed chair Alan Greenspan (in response to the dot-com crash and the 9/11 attacks), and Bernanke seemed to be drawing from the same failed playbook. We would simply replace one bubble with another: in this case, swapping a bubble in U.S. Treasuries (and the U.S. stock market) for the collapsing housing market.
That all still seems true. My crucial mistake back in 2009 was in predicting that other investors would come to agree with my assessment in a year or two. In other words, I thought they would look ahead, realize Bernanke had no exit strategy, and then short the dollar (and other dollar-denominated assets) to avoid holding the bag. More specifically, I thought that commercial banks would eventually realize they needed to get their excess reserves in higher-yielding assets.
Once the commercial banks started this process, the quantity of money in the broader sense (captured in aggregates such as M1 and M2, which include the public's checking account balances at the banks) would begin to reflect the enormous spike in the monetary base the Fed had directly engineered. Remember that in our fractional reserve banking system, when the Fed buys $1 billion (say) in assets and thereby adds $1 billion in new reserves to the system, if the commercial banks proceed to make new loans, then in the process they will create (say) an additional $9 billion in new money, broadly measured. In 2009 I thought more and more investors would begin to anticipate this process, anticipating that the money supply held by the public eventually would start to soar, so that large-scale price inflation would become a self-fulfilling prophecy.
But the U.S. economy has stayed in this holding pattern, where people expect low consumer price inflation and so commercial banks keep their excess reserves earning 25 basis points parked at the Fed rather than make new loans. Thus the process I described above has been thwarted; the quantity of money held by the public right now is much lower than it would be, if the banks decided they would rather make loans and earn a higher interest rate than the 25 basis points currently paid by the Fed.
I do not believe the Federal Reserve can gracefully exit from its current position. Fed officials eventually will be in an untenable position in which they must choose to either (a) crash the financial markets by selling off assets and letting interest rates rise sharply or (b) let the dollar fall quickly in value against consumer goods and services. But in the last six years, they have been granted a very generous grace period before having this hard choice foisted upon them.
According to Austrian business cycle theory, as developed by Ludwig von Mises and elaborated by Friedrich Hayek (who would later win the Nobel Prize partly for this work), interest rates serve a specific purpose in a market economy. Intuitively, the more society saves and is willing to defer immediate gratification, the more we want entrepreneurs to invest real resources in longer-term projects. When the central bank injects new money into the credit markets, this not only lowers the purchasing power of money (other things being equal) but artificially suppresses interest rates and renders long-term projects profitable that in reality should not be pursued.
In the Austrian view, therefore, consumer prices are not a reliable gauge of the "looseness" or "tightness" of monetary policy. Irving Fisher infamously thought the Fed in the 1920s had done a good job because the CPI had been tame, whereas Mises knew that a crash was brewing by the late 1920s.
Fearing an imminent spike in consumer prices because of the Fed's unprecedented actions since late 2008 turned out to be wrong-but if wrong in spirit or merely in timing, only time will tell.
Bernanke's policies were harmful regardless of the impact on the CPI. Pumping enormous amounts of money into the credit markets doesn't make us richer. It just distorts the coordinating function of interest rates. Remember, Greenspan did us no favors by pumping up the housing bubble. Whether or not a massive bout of price inflation breaks out, a crash in the real economy should still be expected.
Robert P. Murphy (rpm@consultingbyrpm.com) is senior economist at the Institute for Energy Research and the author of The Politically Incorrect Guide to Capitalism (Regnery).
High Inflation Still Unlikely
David R. Henderson
Ever since Federal Reserve Chairman Ben Bernanke commenced quantitative easing in October 2008, many commentators have warned about the danger of inflation. There are good reasons to be concerned-including the unprecedented expansion of the monetary base and the Fed's bloated balance sheet-but many Fed watchers are fighting the last war.
The financial crisis has brought such major changes in central banking that uncontrolled inflation from discretionary monetary policy is not as great a danger as it once was. The Fed now has a variety of exotic tools that can prevent any sudden expansion of the broader monetary measures. These tools are partly what have already prevented quantitative easing from causing serious inflation.
Moreover, the Fed monitors banks and other financial institutions so closely that it cannot be caught napping, and implicit inflation targeting has become a dominant Fed goal. The real danger is not runaway inflation. It's that the Fed is becoming more and more intrusive in shaping how national savings are allocated.
The prevalent worry is that once the economy gets back to normal and interest rates start to rise, banks will increase their loans. And when that happens, many fear, the Fed has no viable exit strategy to hold back inflation.
Central banks traditionally dampen inflation by reducing the monetary base via selling off assets or, equivalently, calling in and not rolling over loans. Those who predict future uncontrolled inflation believe this cannot be accomplished quickly enough without major disruption of credit markets. Aggravating this problem is that the Fed's balance sheet now contains large quantities of mortgage-backed securities and long-term Treasury debt, not just the short-term Treasury securities that were its primary asset in the past. The Fed can quickly reduce its balance sheet by not buying new short-term Treasuries when the old ones mature. With long-term Treasuries, by contrast, the Fed must sell many of them on secondary markets. This could drive prices down, disrupting credit markets and causing losses for the Fed on its portfolio.
But the Fed no longer has to rely on dumping assets to impose monetary restraint. It can use four other methods to accomplish the same goal. These comprise either completely new tools or older tools that were previously of minor importance.
They are:
1. Loans to the Fed from the U.S. Treasury.
2. Reverse repurchase agreements (reverse repos)-that is, borrowing by the Fed. The Fed sells a security from its portfolio with an agreement to buy it back. Under new Fed chairman Janet Yellen, the Fed uses this device extensively, borrowing over $200 billion.
3. Term Deposit Facility, a mechanism through which banks can convert their reserves deposited at the Fed (which are just like Fed-provided, interest-earning checking accounts for banks) into deposits of fixed maturity at higher interest rates set by auction (making them just like Fed-provided certificates of deposit for banks). Fed officials have made clear their intention to employ the Term Deposit Facility liberally if necessary. This would drain bank reserves by converting bank deposits at the Fed from implicit loans to explicit, higher-interest-earning loans with fixed maturities.
4. Interest on reserves. The most important way the Fed began borrowing and continues to do so is by paying interest to banks on their reserves. Permission to do so was included in the Troubled Asset Relief Program (TARP) Act, and the Fed started using that power within days. Interest-earning reserves have encouraged banks to raise their reserve ratios rather than expand loans to the private sector. This tool thus constitutes a flexible substitute for reserve requirements.
The rate that the Fed pays on reserves started out as high as 1.4 percent on required reserves and 1 percent on excess reserves, but it is now fairly low on both: 0.25 percent. Yet the alternatives available to the banks are little better, especially after adjusting for risk. It is the gap between these rates that determines the incentive for individual banks to hold reserves. The interest on three-month Treasury bills remains lower, and both T-bills and reserves are assets that impose no legally mandated capital requirements on banks.
By paying interest on reserves, the Fed has made itself the preferred destination for much bank lending. Should market interest rates begin to increase, raising the prospect of increased bank lending and inflation, the Fed can increase the interest rate it pays, locking up bank reserves and keeping reserve ratios high.
These four tools combined make it possible for the Fed to prevent any expansion of the broader monetary measures without selling off any assets. Of course, the Fed may supplement these tools with some asset sales, but sales are unlikely to be large initially. Interest on reserves will almost certainly be the dominant exit tool.
Treasury deposits may not become significant again, given the national government's huge deficits. Use of reverse repos could be somewhat constrained by Fed concerns about the solvency of the counterparties it borrows from, whereas this is not a serious consideration for highly regulated and monitored commercial banks. Term deposits are just a modified way of paying interest to banks.
Another issue that could affect the exact mix is how these tools affect Fed income. Treasury deposits are the only exit tool that cannot reduce Fed earnings. The Fed pays no interest on Treasury deposits directly, so the Treasury would bear the cost of rising market interest rates if it engaged in extra borrowing on behalf of the Fed. This would be offset only partly by the Fed's regular remittances of its excess earnings to the Treasury. On the other hand, paying higher interest on reserves, on reverse repos, and on term deposits would all directly curtail Fed earnings, whereas any large sale of assets could impose capital losses.
Rep. John Campbell, a California Republican who heads the monetary policy and trade subcommittee of the House Financial Services Committee, has warned that central bank losses are "a legitimate concern and something we will be watching." It would be truly ironic if congressional and popular hostility to the Fed pressured the Fed to create more money to keep Treasury remittances flowing, possibly contributing to the very inflation that so many Fed critics fear. And if the Fed's exit strategy coincides with a Treasury fiscal crisis, all bets are off. That last scenario, though, would arise, not from Fed monetary policy per se, but from Congress' and the president's deficits and debt.
My analysis is not advocacy. I do not claim that it is good for the Fed to have these powers. Indeed, as I argued in a presentation at the San Francisco Federal Reserve Bank in April, I would like the Fed to have zero power. The Federal Reserve's sorry century-long record is evidence for its failure. But the issue at hand is whether the Fed's actions will produce high inflation. That is highly unlikely.
Contributing Editor David R. Henderson is an associate professor of economics at the Naval Postgraduate School in Monterey, California, and a research fellow with Stanford University's Hoover Institution. He blogs at econlog.econlib.org.
Neither Hyperinflation Nor a Liquidity Trap
Scott Sumner
The Fed has responded to the Great Recession with a variety of unconventional monetary policies. These policies have been interpreted, or perhaps I should say misinterpreted, in two notable ways.
On the right, many economists and pundits have expressed concern that low interest rates and lots of monetary expansion would lead to high inflation. On the left, Keynesian economists argued that monetary policy is ineffective once interest rates have fallen close to zero. This led them to advocate fiscal stimulus.
Events of the last six years have decisively refuted both of these widely held views. Instead, a relatively small and little-known group-the market monetarists-has offered the most persuasive account of recent policy. Monetary policy continues to be highly effective at near-zero interest rates, but in most cases actual monetary stimulus has been far too weak to promote high inflation, or even an adequate recovery.
I am one of the market monetarists. Here are our arguments:
1. The decline in interest rates to near-zero levels did not represent easy money, but rather the effects of a weak economy. When nominal GDP growth is very slow, as in the early 1930s or in Japan in the 1990s, nominal interest rates tend to fall toward zero. That does not mean "easy money," nor does it mean high inflation is on the way. In contrast, very high interest rates usually occur during periods of very high inflation, when monetary policy is very expansionary.
2. Once interest rates have fallen close to zero, there's no opportunity cost in holding the kind of money produced by the Federal Reserve: currency in people's wallets and bank reserves (which are essentially cash held by commercial banks, often as electronic deposits at the Fed). In previous low-interest-rate environments, such as the 1930s in America and more recently in Japan, central banks were able to "print" lots of money without generating high inflation rates.
In addition, beginning in 2008 the Fed started to pay a small amount of interest on bank reserves, which made banks even more willing to hold onto that cash. Recall that traditional economic theory says that printing money is inflationary because it's a sort of hot potato. The kind of money produced by the Fed prior to 2008 did not earn any interest. Thus, when interest rates are positive, people and banks don't want to hold onto lots of currency and bank reserves. As they try to get rid of these excess cash balances, they purchase goods, services, and assets, driving up prices in the long run. That's why printing money is usually inflationary. But when interest rates are close to zero, the hot potato effect is much weaker, and central banks can print large quantities of money without creating substantial inflation.
If printing money is not inflationary at zero interest rates, what's wrong with the Keynesian argument that we need to rely on fiscal policy because monetary policy is stuck in a "liquidity trap"?
Many Keynesians ignore the role of expectations. Although the U.S. is currently experiencing near-zero interest rates, that won't go on forever. At some point in the future, interest rates will be positive and monetary injections will have an inflationary effect. More importantly, the expectation of higher inflation in the future is expansionary right now. These expectations lead to higher asset prices (stocks, bonds, real estate, commodities, and foreign exchange), which boosts aggregate demand and inflation.
If the Keynesian argument were true, it would be possible for a single central bank to buy up all of the world's assets with newly printed money without creating inflation. Does that sound too good to be true? Do you really believe that a fiat-money central bank would be unable to debase its currency if it wanted to? Do you believe the Fed doesn't know how to create the sort of hyperinflation experienced in Germany in the 1920s and in Zimbabwe more recently?
Contrary to what you may have read in the press, the Fed has never said it was "out of ammunition"; indeed exactly the opposite. When they've made moves like "tapering"-slowing the pace of money printing-it's because they didn't think the economy needed more stimulus, not because they were running out of paper and green ink.
The Keynesians have made a number of predictions in recent years based on the assumption that monetary policy is ineffective when the economy is in a liquidity trap. Perhaps the most famous Keynesian pundit is Paul Krugman, who expressed skepticism about whether the Swiss central bank and the Bank of Japan would be able to depreciate their currencies when interest rates were stuck at zero.
Soon after he expressed those doubts, both central banks undertook bold policies that successfully held down the value of their currency in the foreign exchange market. The Bank of Japan's decision to adopt a 2 percent inflation target had an electrifying impact on asset markets in Japan and led to an acceleration in both inflation and real GDP growth in 2013.
Keynesians like Krugman also predicted that fiscal austerity would slow economic growth. And yet, though the U.S. has been more austere than the eurozone, since 2011 economic growth has been much higher in the U.S. than the eurozone. The reason for the difference is clear: The European Central Bank had a more contractionary monetary policy, leading to below-target inflation, while the U.S. engaged in unconventional stimulus efforts such as quantitative easing and "forward guidance" (trying to shape market expectations through announcements of its near-future intentions), generating slightly higher inflation.
In early 2013, Krugman said the year would be a "test" of market monetarism, specifically the assumption that fiscal policy is ineffective because it is offset by monetary policy. Most Keynesians expected 2013 to see a sharp slowdown, due to fiscal austerity such as higher income taxes, a 2 percent higher payroll tax, and lower government spending associated with the April 2013 sequester.
In late 2012, the Fed pursued a third round of quantitative easing and aggressive forward guidance with the goal of offsetting the expected fiscal austerity. The results of this experiment could not be clearer. Contrary to the Keynesian prediction, GDP growth did not slow. Indeed, real GDP growth from the fourth quarter of 2012 to the fourth quarter of 2013 was nearly double the pace of the previous four quarters.
We've seen plenty of experiments in Switzerland, Japan, Britain, and the U.S., which clearly demonstrate that monetary policy can be effective at near-zero interest rates. This should have been no surprise, as even Franklin Roosevelt was able to stimulate the economy in 1933 by devaluing the dollar when interest rates were close to zero.
Market monetarists succeeded in our preÂdictions because we take markets seriously. Conservatives who predicted higher inflation should have seen the low inflation forecasts in the financial markets as a warning sign that their models were flawed. Liberals who thought that monetary policy couldn't work at near-zero interest rates should have paid more attention to the fact that financial markets often rallied strongly on signals of monetary stimulus and fell sharply on signs that the stimulus would be cut back.
Market signals aren't perfect, but they're much better than the predictions of academic economists or government bureaucrats.
Scott Sumner (ssumner@bentley.edu) is a professor of economics at Bentley University.
The post Whatever Happened to Inflation? appeared first on Reason.com.
]]>Like Obama, Rep. Nancy Pelosi (D-Calif.) blames partisan bickering in Washington for the nation's economic woes and recently accused Republicans of having "passed bills that would destroy up to 2 million jobs—nearly 10,000 jobs per day" in the 200 days since she was booted from her role as House speaker. Pelosi, of course, is an old hand at job pivotry. She prefers her jobs bought and paid for by federal money, and in a pleasing shade of green.
Republicans have their own jobs agenda, but mostly prefer to talk trash about the Democrats. "Spurring jobs and the economy is always next on the Obama Administration's to-do list," sniped Current House Speaker John Boehner (R-Ohio) in an August 3 blog post, "right after more spending, more taxing, and more regulating."
Meanwhile, the American people are raising a collective skeptical eyebrow at both parties on the employment front. A July Pew Research poll showed an even 39-39 split on which party Americans trust more on jobs. But a CNN/ORC poll released Friday finds that only 29 percent of respondents think there will be more jobs in their communities a year from now—and 26 percent think there will be fewer jobs.
In an effort to produce real free-market ideas for boosting employment, Reason asked some of our favorite economists, writers, professors, and entrepreneurs for one concrete policy change they would recommend that would increase job growth. —Lucy Steigerwald
Robert Higgs
Repeal of ObamaCare would probably do wonders to spur hiring, especially for permanent positions. Compensation for such jobs usually includes a benefits package with health care insurance, as well as a money wage or salary. Health care insurance often constitutes a major part of the employer's cost of keeping a permanent worker on the payroll, and anything that makes this cost difficult to forecast makes employers leery to take on new workers.
ObamaCare—the Patient Protection and Affordable Care Act—is a gigantic statute, and it would be a big bite for employers to digest in any event. But as it stands, it serves mainly as an announcement that a large number of legal black boxes must be filled with new regulations that various administrative agencies will eventually promulgate. As Gary Lawson has written recently, "Implementation of the Act will require many years and literally thousands of administrative regulations that will determine its substantive content and coverage."
This situation creates tremendous uncertainty that affects virtually all firms. After all, no matter how firms may differ in other regards, they all hire employees, and in most cases employee compensation amounts to a major part of their total cost of operation. Repeal of ObamaCare would have many benefits, but surely a great benefit would be the removal of an ominous cloud of uncertainty about a critical matter that now hangs over the entire labor market. In the face of this uncertainty, few firms have been, or will be, willing to assume the risk associated with increasing their permanent, full-time workforce.
Robert Higgs is a senior fellow in political economy at the Independent Institute. He is the author of Crisis and Leviathan: Criticial Episodes in the Growth of American Government, and several other books.
Deirdre McCloskey
"Jobs" are deals between workers and employers, and so "creating" them out of unwilling parties is impossible. The state, though, can outlaw deals, and has. So: eliminate the minimum wage for people younger than 25. The resulting boom in jobs for young people will amaze. Maybe it will inspire voters to get the state out of the job-outlawing business. Probably not, so sure are we that the state "protects" by stopping deals between willing parties.
Deirdre McCloskey is a professor of economics, history, English, and communication at the University of Illinois at Chicago, and author of The Bourgeois Virtues: Ethics for an Age of Commerce.
Amity Shlaes
The single thing the U.S. could do to ensure long-term growth, including that of jobs, is to reform our Federal Reserve so that monetary policy is rules-based, not personality-based. Even a return to the gold standard would do, though it is also possible to fashion a monetary regime under which the currency is pegged to a basket of commodities.
Amity Shlaes is a senior fellow in economic history at the Council on Foreign Relations. She is the author of The Forgotten Man: A New History of the Great Depression. Her biography of Calvin Coolidge will be released next spring.
John Stossel
Close the Departments of Labor, Commerce, Agriculture, Energy, and HUD, then eliminate three fourths of all regulations.
John Stossel's show Stossel airs Thursdays at 10 p.m. on Fox Business Network. He contributes a regular column to Reason.com.
Donald Boudreaux
My answer (within the realm of "remotely politically possible") is: Replace all income taxes, including that on capital gains, with a consumption tax. But do this only if the Constitution is amended to prevent government from taxing incomes and capital gains.
A second, less radical, proposal is to eliminate capital gains taxes and amend the Constitution to prevent Uncle Sam from taxing personal and corporate incomes at marginal rates higher than 20 percent.
Donald Boudreaux is a professor of economics at George Mason University, and blogs at Cafe Hayek.
Bryan Caplan
Easy: Cut employers' share of the payroll tax.
Bryan Caplan is a professor of economics at George Mason University. He is the author of The Myth of the Rational Voter: Why Democracies Choose Bad Policies, and most recently, Selfish Reasons to Have More Kids: Why Being a Great Parent is Less Work and More Fun Than You Think.
Bruce Bartlett
I don't believe there is any way to increase employment significantly without raising the rate of economic growth. Therefore, the real question is how to raise economic growth. I continue to believe that the economy's fundamental problem is a lack of aggregate demand.
I think a dose of inflation is just what the economy needs and libertarians should stop being so obsessive about it. Moreover, I think at some point they need to admit that the Fed cannot raise aggregate demand by itself when the economy is in a liquidity trap, which it obviously is based on the level of interest rates being close to zero.
Under these circumstances, I believe that some form of aggressive fiscal policy is necessary to get money circulating, raise the velocity of money, and get the economy out of a liquidity trap. I do not believe, under current circumstances, there is any type of tax cut that would achieve this goal; only direct spending by the government on purchases of goods and services will help. Therefore, the Fed will, somehow or other, have to figure out how to raise aggregate demand by itself.
The only other thing I can think of to raise growth would be a deliberate devaluation of the dollar, which would raise exports. Theoretically, the Fed could buy as much foreign currency as necessary to bring the dollar down. But this is impractical because foreign countries can retaliate by buying dollars with their own currency or impose restrictions on U.S. imports. Any policy of devaluation would be strenuously opposed domestically by those who are obsessed with the idea that the dollar should be strong regardless of the economic conditions.
I realize that everything I have just said is totally contrary to the libertarian worldview. However, I believe that implementation of libertarian policies, such as cutting spending and tightening monetary policy, under current economic conditions will only make it worse. I support any regulatory measure anyone can think of to reduce unemployment, but am disinclined to think there are any that will have more than a trivial effect under current macroeconomic conditions.
Bruce Bartlett was a domestic policy adviser to Ronald Reagan and a treasury official under George H.W. Bush. His most recent book is The New American Economy: The Failure of Reaganomics and a New Way Forward.
Jeffrey Miron
Policymakers should stop worrying about job growth. Instead, they should focus on eliminating economic policies that impede economic efficiency—runaway entitlements, a horrendous tax code, excessive regulation, impediments to free trade, and more—and then let the job situation fix itself.
Jeffrey Miron is the director of undergraduate studies and a professor of economics at Harvard University.
John Berlau
Repeal portions of the Bush-era Sarbanes-Oxley Act to make it easier for smaller companies to raise capital by going public, and thus expand and create thousands more jobs.
Repeal portions of last year's Dodd-Frank Wall Street Reform and Consumer Protection Act, which has created hundreds of pending rules causing uncertainty and a halt in hiring for everyone from banks and credit unions to retailers and manufacturers that extend credit or hedge financial risks with derivatives.
Pass the bipartisan Small Business Lending Enhancement Act—S. 509 by Sen. Mark Udall (D-Colo.), and in HR 1418, by Rep. Ed Royce (R-Calif.)—to lift the aribitrary cap on business lending by credit unions. The Credit Union National Association estimates that easing this barrier would create over 140,000 jobs in the first year and thousands more in the years after that.
John Berlau is director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute.
Allan Meltzer
We have made the mistake of using short-term policy changes to try to cope with a long-term problem. There are several long-term changes called for. There is great uncertainty and lack of confidence in the future. That reduces investment and employment. One change that would reduce uncertainty is a five-year moratorium on new regulation except for national security. Another would be a budget agreement that made the debt sustainable. Not likely. Third; corporate tax rate reduction paid for by closing loopholes. Finally, we need assurance that we won't have inflation. A credible, enforced inflation target would work.
Allan Meltzer is a professor of economics and the political economy at the Carnegie Mellon University Kepper School of Business.
Ira Stoll
Congress should stop extending unemployment benefits, and better yet, restructure the unemployment insurance program or block-grant it to the states to allow them to experiment with ways of doing so. The idea is to change the program so it creates an incentive for recipients to get a job, rather than an incentive for them to remain unemployed.
This could involve altering the unemployment benefit formula so that the amount of the payment gradually decreases over time, reducing the propensity of beneficiaries to stay on unemployment until they frantically search for a job and find it just as the benefits run out.
Or it could involve allowing states "the flexibility to convert their unemployment insurance payments from checks sent to the jobless into vouchers that can be used by companies to hire workers," as Bloomberg News columnist Jonathan Alter suggests, relaying an idea from a Democratic candidate for U.S. Senate from Massachusetts, Alan Khazei.
Or it could involve changing the program so recipients get a hefty share of their benefits up front, as a lump sum. They can then use the money as capital to start small businesses. Or if they find a job quickly, they can save or invest or spend the money. (No repeat passes, though; the idea is to increase incentives for finding or creating a job, not rewards for people who get themselves fired.) Another approach might be to fold unemployment together with health, college, homeownership and retirement as expenses that people can save for in a tax-favored account.
Ira Stoll is the editor and founder of FutureOfCapitalism.com and the author of Samuel Adams: A Life. His weekly column appears at Reason.com.
Walter Olson
If I could press a button and instantly vaporize one sector of employment law, I think I'd pick age discrimination.
Its beneficiaries are among those needing least assistance. The main cash-and-carry effect of age-bias law is to confer legal leverage on older male holders of desirable jobs, such as managers, pilots, and college professors, who by threatening to raise the issue can extract ampler severance packets than might otherwise be offered them. Much legal talent is wasted in the resulting exit negotiations, which seldom seem to rouse the ire of critics of gaudy executive pay, golden parachutes and so forth.
It blatantly backfires on those it tries to help. Once cut loose from the old job, those same buyout recipients find it harder to land the next high-level job because of the perception that older hires are more likely to need buyouts not far down the road.
It generates pointless avoidance mechanisms. Ask your HR director about the costly stage in layoff strategy known as "age-balancing the RIF" or about the many small-talk questions you're not supposed to ask at job interviews for fear of seeming interested in the subject ("I notice you're a veteran. Which war?") or about the brain-cracking legal headaches that arise from the premise that (at least in some situations) the design of pension plans is supposed to take no notice of age.
Its intellectual basis is lighter than helium. Race, sex, sexual orientation and disability each form the basis of a major identity politics movement. But really: "ageism?" It's one thing to abridge liberty to expiate the national guilt of antebellum slavery, but can anyone keep a straight face in proclaiming persons of late middle age a historically oppressed class?
Please, I want to see this law repealed before I'm too old to enjoy it.
Walter Olson is a contributing editor to Reason, senior fellow at the Cato Institute, and proprietor of Overlawyered.com.
Peter Schiff
To make the greatest impact on persistent unemployment, the government should pursue policies that allow the free market to set wages, benefits, and all issues related to employment. Just as employees are allowed to leave jobs for whatever reason, employers should be allowed to hire and fire based on any criteria without fear of litigation. In other words, liability cost for hiring employees should be minimized. Employees become easier to hire once employers know that their downside risks are minimized. In addition, all labor laws protecting employees from employers, including minimum wage laws, should be repealed.
Employment is a voluntary relationship between two parties. Our laws should reflect and support that concept to the highest extent possible. Employees do not qualify for special privileges (inappropriately labeled worker's rights) simply because they accept a job, and employers do not lose their rights and become subjected to special obligations just because they hire. The playing field should be level.
Peter Schiff is the CEO of Euro Pacific Capital and the author of How an Economy Grows and Why it Crashes.
Alex Tabarrok
QE3: Fed should buy lots of long term T-bonds.
Alex Tabarrok is the Bartley J. Madden Professor of Economics at the Mercatus Center at George Mason University.
Fred L. Smith
Approve the Keystone XL Pipeline: 20,000 jobs created. The 1,700 mile Keystone XL Pipeline would link expanding Canadian crude production from tar sands with America's first-class refining hub in the Midwest and along the Gulf. The $7 billion project would roughly double U.S. imports of tar sands oil from western Canada.
Because the Keystone XL pipeline crosses an international border, the primary permitting agency is the State Department. However, oil production from tar sands is more carbon-intensive than traditional production, so environmentalist groups are staunchly opposed to it. As a result, the project has been in a permitting limbo for three years. By approving the project in short order, President Barack Obama would directly create more than 20,000 high-wage manufacturing jobs and construction jobs in 2011-2013, according to an independent analysis by the Perryman Group.
Fred L. Smith Jr. is the president of the Competitive Enterprise Institute.
The post What Would You Do to Improve Job Growth? appeared first on Reason.com.
]]>After decades of relative confidence that the price of milk would be more or less the same today as it was yesterday and last year, Americans are once again wondering whether to keep what money they have in mattresses, gold bars, or banks. Has the time come to stockpile canned goods and pick up a wheelbarrow for transporting currency, or should we be afraid of the opposite—a prolonged contraction that causes prices to crash?
In mid-July, inflation seers got their first juicy slice of supporting data when June wholesale prices jumped 1.8 percent, the sharpest rise in two years and twice the increase most analysts expected. Gold prices surged on the news to nearly $940 an ounce. Just before those figures were released, reason asked eight free market economists to assess the short-, medium-, and long-term prospects for inflation and to say what, if anything, can or should be done about it.—Katherine Mangu-Ward
Inflation Is Already Here; Next Come Rising Prices
Peter Schiff
Despite economists' efforts to obscure inflation in a tangle of jargon, it is an extremely simple phenomenon. Almost every dictionary defines inflation as an expansion of the money supply, not rising prices.Although more money may not immediately translate into rising prices, over time the correlation is extremely reliable.
Inflation has always been a means for governments to raise revenues without taxation. When gold was the only accepted currency, governments inflated through debasement of coins, surreptitiously blending base metals into gold. By melting down one real coin to make two alloyed coins, money could be "created" with little effort. Nice trick. But eventually consumers caught on that their coins were bogus. Their reaction was often violent.
Paper money largely solved this problem by allowing governments to print money, or extend credit, at will. And thanks to the overly complex Rube Goldberg explanations of inflation devised by academics, such as "the wage-price spiral," "demand pull," and "cost push," governments can
inflate without admitting culpability for rising prices. The Federal Reserve's monetary base statistics show that in the last year the money in circulation has increased far faster than at any other point in American history. Thus, by the dictionary definition, we have inflation. But prices
have been relatively stable because downward recessionary pressures are currently counterbalancing the upward pressures of the expanded money supply.
The new money has been largely parked in financial institutions. Thanks to government prodding and aggressive stimuli, it will soon be showered on the economy at large.When the tide rolls in, there will be more money chasing fewer goods. (Recessions reduce the supply of things.) The result: higher prices.
The government clings to the fantasy that it will be able to "mop up" this excess liquidity before the business end of inflation kicks in, effectively taking money back out of circulation. Good luck with that. Recent history clearly shows that the authorities have no political will to dispense tough medicine."Removing liquidity"would require either much higher interest rates or a severe curtailment of credit. But politicians believe that credit is the "lifeblood" of our economy. President Barack Obama himself has said so. If the Fed was unwilling to raise interest rates substantially in the middle years of this decade, when the economy seemed healthy, how can we expect it to do so now?
Peter Schiff (info@europac.net) is president of Euro Pacific Capital and author of Crash Proof: How to Profit From the Coming Economic Collapse (Wiley).
Why Forecasts Are All Over the Map
Jeffrey Rogers Hummel
Under normal circumstances, a massive and sudden monetary explosion—like the one initiated by the Federal Reserve after September 18, 2008, which took us from a monetary base of $850 billion to $1.7 trillion in three months—would bring skyrocketing inflation. But these are not normal circumstances. A high demand for liquidity, mostly on the part of banks, has thus far prevented inflation from taking off. In fact, almost all of that increase was concentrated in bank reserves, which during that short period mushroomed by an incredible factor of 13.
On one hand, the Fed's expansion of the base encouraged banks to make loans, thereby increasing the amount of checkbook money: an inflationary step. On the other hand, it simultaneously paid banks to hold more reserves: a deflationary step.Is it any wonder that economists' forecasts have been all over the map? Ben Bernanke, in what must stand as the most egregious example of central planning hubris on the part of any Fed chairman since the institution's founding, seems convinced that fine adjustments to these two controls will allow him to manage the price level perfectly.
Buried within the bailout bill of October 3, 2008, that set up the Troubled Asset Relief Program (TARP) was a provision permitting the Fed to pay interest on bank reserves. This seemingly technical change not only gives banks an incentive to hold reserves rather than make loans; it also essentially converts reserves into more government debt. Fiat money traditionally pays no interest and therefore allows the government to purchase real resources without incurring any future tax liability. Economists refer to this revenue from creating money as seigniorage. Federal Reserve notes will continue to earn no interest. But now the seigniorage that government gains from creating bank reserves will be much reduced, if not entirely eliminated.
Outside of America's two hyperinflations (during the American Revolution and under the Confederacy during the Civil War), seigniorage peaked during World War II, to nearly a quarter of the war's cost,or about 12 percent of GDP. By the Great Inflation of the 1970s, financial innovations and market sophistication had managed to reduce seigniorage to only 2 percent of federal revenue, which translates into less than half a percent of GDP. Now with the Fed having to divert potential government revenue to pay interest on base money held by banks, seigniorage has virtually been eliminated as a source of future funding. And this constraint will become tighter as people replace the use of currency with bank debit cards and other forms of electronic fund transfers.
This is not to say that monetary increases cannot still generate high inflation rates. But if the U.S. does get high inflation,even inflation exceeding double digits,the government is still confined to essentially two sources of revenue: 1) current taxes and 2) borrowing, which represents future taxes.
Interest-earning bank reserves also blur the distinction between monetary policy and fiscal policy. To see how, imagine the extreme case:Assume the interest the Fed pays on reserves is exactly the same as the interest the Treasury pays on its outstanding debt. Then Fed open-market operations are no longer exchanging government debt for created money; they are exchanging one form of government debt for another form. Monetary policy becomes entirely neutral and impotent, in a self-fulfilling Keynesian prophecy.
Jeffrey Rogers Hummel is an associate professor of economics at San Jose State University.
Inflation? We Should Be So Lucky
Scott Sumner
This crisis has been poorly understood by economists from the very beginning. The original subprime crisis of 2007 had a relatively modest impact on both financial markets and the broader economy. The much more severe crash of late 2008 resulted from monetary policy (unintentionally) becoming far too contractionary for the economy's needs. Most economists missed this problem, as they are used to looking at faulty indicators such as nominal interest rates and the monetary base (which is the money actually produced by the Fed-cash plus bank reserves). Milton Friedman and Anna Schwartz showed that these two indicators gave highly misleading signals during the Great Contraction of 1929-33. They are no more reliable in the current crisis.
It is discouraging to see so many free market economists now warning of an inflationary time bomb. I'm afraid that New York Times columnist and recent Nobel Prize winner Paul Krugman is right: The real problem is that inflation is likely to remain too low.
In a fiat money world the only sensible indicator of monetary policy is market expectations of growth in the variable actually being targeted by the central bank. That variable might be the Consumer Price Index, but I believe the economy would be more stable if the Fed targeted nominalGDPat a roughly 5 percent annual growth rate.We know from various asset markets that nominal growth expectations turned quite bearish after mid-2008. This severely depressed aggregate demand and dramatically worsened the debt crisis.
Almost everyone has reversed the causation, assuming that the intensification of the financial crisis caused the big drop in nominal income,whereas the reverse is closer to the truth. Nine months later the markets continue to signal that inflation and nominal growth will remain below the Fed's
implicit target for years to come. Monetary policy remains too contractionary, which has led to a very costly reliance on fiscal stimulus.
Most economists have a deeply ingrained instinct that printing money inevitably leads to inflation. Although our gut might tell us that the recent explosion of the monetary base is reminiscent of Germany circa 1923, it is actually more like Japan after 1998. Yet Japan has seen almost no growth in nominal incomes since 1993. This isn't to say that Japan was "stuck"in a liquidity trap; although nominal interest rates cannot fall below zero, monetary policy could have sprung the trap if the Bank of Japan had been willing to devalue the yen or commit to a policy of mild inflation. Zero interest rates reflected deflationary expectations, not "easy money."
Once the Fed began paying interest on reserves in October 2008, banks hoarded massive amounts of excess reserves, and monetary policy became much less effective. This deflationary policy was analogous to the Fed's 1936-37 decision to double reserve requirements, but it was even more costly. Both policies encouraged banks to hold on to reserves, which prevented monetary injections from stimulating the economy.
It may be hard for free market economists to admit they were wrong about inflation, but I'm afraid that is exactly what the markets are telling us. If we don't pay attention, then monetarist, supply-side, and Austrian ideas may be discredited for all the wrong reasons.
Scott Sumner (ssumner@bentley.edu), a professor of economics at Bentley University, focuses on monetary economics, particularly the role of the gold standard in the Great Depression. He blogs at blogsandwikis.bentley.edu/themoneyillusion.
The Choice: Great Depression or Great Inflation?
Randall Parker
Now that it appears the threat of a worldwide financial market meltdown has subsided, the public is assessing the threat of future inflation.Many commentators are speaking as if massive 1970s-style inflation is a foregone conclusion and claiming the Fed has done a great wrong.
Hardly. How about a recap of Federal Reserve actions with some historical perspective?
Beginning in August 2007, the Fed had a choice: either increase the monetary base dramatically and stop financial markets from unraveling, or let the market take its course and eliminate the threat we currently face of potential inflation. In other words, would you rather have a Great Depression or the threat of a Great Inflation? I know which one I'm
picking, and you should not doubt what side Ben Bernanke picked either.
The Great Depression happened as it did because the Fed of the 1930s was always worried about the next inflation in a world economy that was dead from deflation. Ben Bernanke knows this history and its lessons better than anyone else walking around this big blue marble. We may yet have a depression, but it won't be because the Fed abdicated its responsibilities and let the money supply fall by 33 percent like it did in the 1930s.
The Fed has blown up its balance sheet from $902 billion on August 8, 2007, to more than $2.3 trillion today, mostly in new lending facilities created to earmark credit for specific areas of our financial markets. The danger is that the Fed's independence has been compromised in the process. Yet the money supply has increased only by about 15 percent. That is big, to be sure, but increasing the monetary base is not the same as increasing the money supply dollar for dollar.
The threat of inflation is real, but the Fed has two ways out. First is the new policy of paying interest on bank reserves. It can increase that rate as high as it wishes and thereby stop banks from loaning excess reserves and creating money. Second, there is talk of permitting the Fed to issue its own debt. This too would drain the monetary base and prevent money creation. Of course, the Treasury could take the assets off the Fed's balance sheet in a new Treasury-Fed Accord like the one reached in 1951. Don't hold your breath.
Inflation is a threat. But I would not be too ready to cash that ticket as a sure thing.
Randall Parker, a professor of economics at East Carolina University, is working on a book titled Interwar Historical Antecedents of Modern Inflation Targeting. He blogs at randallparker.blogspot.com.
Greenspan's Fear of Deflation Is What Got Us Here
James Grant
By the standards of any other moment in history, the world today is a cornucopia. Prices fell steadily in the last quarter of the 19th century, another time of bounding human progress. What has been holding them up in the 21st century? Why, our central bankers have. In 2002-03, soggy consumer prices alarmed Alan Greenspan, then chairman of the Federal Reserve, and Ben Bernanke, then
a member of the Fed's Board of Governors. "Deflation!" they cried.
Inflation is too much money. Rising prices are a symptom of that excess. Deflation is too much debt. Falling prices are a symptom of that excess. But Greenspan and Bernanke defined deflation, if they defined it at all, as "falling prices." They said nothing about debt.They made no attempt to distinguish between the Wal-Mart business model (i.e., everyday low and lower prices) and a collapse in prices brought about by desperate debts. So the Bank of Alan Greenspan pressed interest rates to the floor. It was the ensuing derangement of credit- the crackup in subprime mortgages, in the debts of sub-prime corporations, and in the banks that trafficked in those items-that led us to the present pass. To forestall an imagined deflation, the Fed instituted a real one.
Now comes the money printing. The Federal Reserve has set out to debase the dollar. It makes no bones about it. "Excess reserves" is one marker of Fed policy. You may think of these balances as monetary dry tinder.At the end of 2007, excess reserves totaled $1.8 billion.Today, they stand at $744 billion.
The Fed will surely haul away this underbrush before it can catch fire, many on Wall Street insist. Perhaps. But in the wake of the previous two recessions, ending in 1991 and 2001, the Fed was slow to extinguish the extra dollars it had printed in an attempt to hasten economic recovery. And in neither one of those episodes was the nation's financial system as close to collapse as it came last year. I predict that the Fed will indeed vanquish deflation. It will vanquish deflation by creating a new inflation. You may wish it had never tried.
James Grant (jgrant@grantspub.com) is the editor of Grant's Interest Rate Observer.
A Little Inflation Can Be Good for You
Steven Gjerstad and Vernon L. Smith
Long considered the bane of modern economies, moderate inflation-around 6 percent per year for several years—may be the only way out of our current dilemma.
It would be worthwhile to carefully consider the benefits of and alternatives to inflation before taking measures to curb it. Moderate inflation, if it can be achieved, will gradually reduce the debt burden of households and stimulate household spending, generating a decentralized, market-driven recovery.
Two questions arise. First: How does inflation affect long-term creditors? Second, and perhaps more difficult: How do we induce inflation when private demand for credit is suppressed? Credit is a crucial element of the money supply. If households and firms are determined to reduce debt loads, their declining demand for credit will undermine efforts to increase the money supply.
Inflation involves a tradeoff for long-term creditors in mortgage and corporate bond markets. The values of earlier loans or bond issues depreciate, but delinquencies and foreclosures fall as asset values and consumer spending recover. The real value of U.S. Treasury debt also declines with inflation, but other assets will appreciate as consumer spending recovers. Most debt holders should benefit from moderate inflation, except those whose only investments are U.S.Treasury debt.
Although inflation may be the best way out of a deflationary spiral, the Japanese experience suggests we may not be so fortunate. In 2005, after 15 years of a debt-deflation spiral in Japan, private firms finally became net borrowers (and hence investors) again. Throughout this terribly long and arduous recovery, Japan relied on public spending and an export-driven industrial sector to maintain production and employment and to work off the stultifying debt loads of households and firms from prior asset bubbles. Political consensus for public sector spending over a 15-year period will be difficult to maintain in the United States. Strong exports that helped sustain Japan through the "lost decade" depended on the rapid growth of worldwide demand.Long-standing American trade deficits and the slowing worldwide economy make export-driven growth an unlikely way out of the U.S. downturn.
Declining demand for private credit reduces the money supply, which in turn reinforces the deflationary spiral. Even the large increase in the Federal Reserve balance sheet in September 2008 may not presage inflation. In usual circumstances, the Fed's asset purchases increase bank reserves and lead to more lending, but its recent purchases have not had the usual effects. Banks are reluctant to lend to any but the best credit risks, while many households and firms are reluctant to buy assets in a declining market.Japan has faced this dilemma for almost 20 years now.
If inflation does arise, the excess reserves of banks provide a simple means to contain it.The enormous increase in the Fed balance sheet from about $800 billion to $1,800 billion creates an unprecedented surge in the monetary base, but the Fed could limit the impact of this increase by placing a lower limit on excess reserves and thereby control credit creation by banks. Consequently, it appears now that deflation could pose a more serious risk than inflation.
Steven Gjerstad (gjerstad@chapman.edu) is a research associate at Chapman University. Vernon L. Smith (vsmith@chapman.edu) is a professor of economics at Chapman University and the 2002 Nobel laureate in economics.
The Fed Fears Unemployment More Than Rising Prices
Donald L. Luskin
Inflation is inevitable in the intermediate and long term. Short-term inflation, however, is unlikely, because the recent financial crisis had the deflationary effect of creating enormous global demand for money balances.
The Federal Reserve responded to that demand with an enormous increase in the money supply. Politics and economics conspire to make it unlikely that the Fed will contract that supply rapidly enough to prevent inflation as the crisis ebbs and recovery ensues.
First, the economics. The Fed makes its policy decisions under extreme uncertainty and therefore must err on the side of avoiding unacceptable risks even if that means deliberately taking on acceptable risks. To the Fed, deflation is an unacceptable risk. Most economic historians, including Ben Bernanke, believe that deflation was the greatest single cause of the Great Depression; averting a repetition of that was uppermost in Bernanke's mind as he expanded the money supply so copiously during the last three quarters.
Inflation, on the other hand, is an acceptable risk. While it leads to the diminution of the real value of savings and induces all manner of economic distortions, the Fed feels confident that it is not catastrophic. Thus the Fed will surely keep the money supply extremely generous even as the economy recovers, preferring to accept the near certainty of inflation rather than any risk at all of deflation.
Second, the politics. The Fed is tasked by statute not only with ensuring "price stability"-that is, no inflation -but also with achieving "full employment." As the economy slowly recovers from an unprecedented global recession, the Fed's employment mission may have to take priority over its inflation mission. Unless inflation becomes extreme, employment is a much more potent political concern.
The Fed is likely at some point to judge that the risk of deflation has passed; yet it will not dare to take the restrictive policy actions required to quell inflation for fear of disrupting recovery in the labor market. If Ben Bernanke signals to the Obama White House that he will not support the labor market at the price of inflation, I have no doubt he will be replaced by someone else who will.
Donald L. Luskin (don@trendmacro.com) is chief investment officer of Trend Macrolytics.
The post Inflation Returns! appeared first on Reason.com.
]]>1.) More Borrowing: "Obama's going to try to borrow money from the Chinese or the Japanese or the Saudis. Hopefully they'll have the good sense not to lend it to us. Eventually people are going to realize that lending money to the U.S. is like lending money to Bernie Madoff, because we're not going to give it back."
2.) More Spending: "Is it really so bad if Americans stop buying things? Does it mean that people's houses will go down in value? Yes. Does it mean that people who work in the service sector will lose their jobs? Yes. But right now we're living in a fantasy."
3.) More of the Same: "In 2003 the greater economic disaster that I predicted wasn't the economic crash that has already happened. It was what the government was going to do after the crash happened. All the people who are telling us that we need the stimulus plan now are the same people who were telling us how great the economy was then. They're going to make mistakes."
The post Economic Forecast appeared first on Reason.com.
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