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Crying Wolf and Meaning It

July 17, 2010

Bruce Bartlett’s latest column goes into detail regarding what exactly the Fed can do to spur growth, given that fiscal stimulus is, for all intents and purposes, off the table.  The bottom line is that Bernanke has his hands tied just like everybody else does, if not to the same degree — the Fed already has a truckload of bad assets on its balance sheets that it had to buy up during the financial crisis, so it’s not really in the mood to purchase more assets, and it can’t physically make banks start lending.  There is an idea here that I find intriguing:

Some economists suggest that the Fed should publicly announce that it plans to increase the money supply by whatever amount is necessary to get prices rising again; that is, to have an explicit inflation target. But as noted earlier, there is a problem in that all the Fed can really do is create bank reserves; it can’t make banks lend or make money circulate. But the hope is that if people really believe that the Fed can and will create inflation then it might change psychology and get people to start spending on cars, houses and other goods before their prices rise. This would raise velocity, reverse the deflation and hopefully create self-sustaining growth.  [E.A]

It’s the monetary equivalent of a fire sale.  A host of liberal economists have been trying to convince us for a good solid while now that the inflation hawks are out of their minds, which makes sense since the CPI hasn’t changed at all since 2008 even though the Fed has tried to increase the money supply a whole lot since then.  They’ve been doing that because inflation hawkery is an idea to which plenty of people are subscribing — if there’s anything the large-scale purchase of gold tells you, it’s that people are worried about hyperinflation.

If the Fed were to announce plans to deliberately created inflation — provided that enough people in this country would watch the news enough to find out — then that might lead people to rush out and use their 2010 dollars to purchase things that 2011 and 2012 dollars won’t.  I actually like this idea — I’m well connected enough to plenty of people who are genuinely concerned about inflation, despite what the numbers say.  But what are the odds that Bernanke and Co. will actually do this?

However, the Fed views its primary mandate as price stability and the idea of intentionally creating inflation runs deeply against its grain. Although some Fed officials such as Eric Rosengren of the Federal Reserve Bank of Boston have expressed concern about deflation, others such as Thomas Hoenig of the Federal Reserve Bank of Kansas City think inflation is right around the corner because of the increase in the money supply over the last two years.

True enough.  It’s worth noting that (via Yglesias) it seems like the Fed is literally planning to miss its inflation targets over the next two years.  The economy’s not picking up quickly enough for that, and the odds that we’ll hit another downturn, cyclically speaking, before our long-term trends return to normalcy is increasing with each new poor economic report.  The fire sale idea may not be a good idea on the regular, but I think it’s a pretty good idea right now.

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