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Home Publications Blogs Beat the Press Federal Reserve Board Credibility, Plus 50 Cents, Will Get You a Cup of Coffee

Federal Reserve Board Credibility, Plus 50 Cents, Will Get You a Cup of Coffee

Wednesday, 25 April 2012 23:13

Since folks have asked my thoughts (you had to ask?) on the Krugman-Bernanke debate, I will throw in my two cents. The question at hand is whether the Fed can plausible generate more inflation, and thereby lower real interest rates and reduce the unemployment rate by announcing a commitment to higher inflation rate over the near future. This could mean, for example, committing itself to 4 percent inflation over the next 5 years.

If this policy was successful, it would lead to lower real interest rates, which would in turn lead to more consumption and investment. Ideally we would also see a decline in th real value of the dollar, leading to more net exports, the essential long-term path to full employment.

My view is that this path would likely be successful, if the Fed were really committed to it. That means continually buying up vast amounts of assets if the inflation rate did not appear to be rising. This should ultimately freak enough investor types into thinking that Bernanke was sufficiently nuts that he could cause inflation. They would then hedge themselves against this risk by buying up all sorts of commodities to protect against inflation, which would then lead to inflation.

That looks like a pretty compelling story to me, but perhaps at least as important, I don't see the downside. Bernanke's obsession with the Fed's inflation fighting credibility (like the ECB's) is really pathetic. How much is this worth when you just wrecked an economy with your incompetence in protecting against asset bubbles?

Other things equal, it is better to have central banks that have some credibility in fighting inflation, but how does this compare against tens of millions of people in the U.S. and euro zone being unemployed? If the latter is such a small matter, would the inflation fighters volunteer to surrender their jobs so that some of the unemployed can work?

Finally, if buying up tons of assets will not cause inflation, then there is definitely no excuse not to do it. The Fed can hold $10 trillion in assets and pay the interest to the Treasury each year. Currently it is refunding about $80 billion a year to the Treasury from its interest in assets.

Suppose this was instead $400 billion a year or $4 trillion over a decade? That should make even the most ardent deficit hawk happy. There would be no deficit problem in that story, which would mean that we can freely spend on all sorts of things that can boost growth and help people. Tell me again that story about Fed credibility? 

Comments (14)Add Comment
written by Chris, April 26, 2012 1:43
I suspect Ben has been talking too long and too much to ECB types and gotten infected by their thinking
written by PeakVT, April 26, 2012 3:18
Chris - I think the entire institution identifies with the banksters, from the BoG on down. And Bernanke isn't the most anti-worker/pro-banker member of the BoG.
written by JSeydl, April 26, 2012 6:38
In economics, everything must be placed into context. A 10,000 square foot home, even though very large, does not seem large in a neighborhood in which every other home is +15,000 square feet.

Central bankers, however, never use this logic when it comes to inflation. It is always assumed that 2 percent inflation is the best policy, regardless of the context. This is catastrophic because context is undeniably important for monetary policy. 2 percent inflation might seem like a good policy when the economy is operating at full employment and there are no asset imbalances, but 2 percent inflation is clearly too low following an $8 trillion residential real estate boom and bust. Higher inflation helps to speed up the deleveraging process following a debt-fueled asset boom and bust, and Bernanke knows this.

The real issue is that higher inflation hurts the rentier class and helps the labor class. Because the rentier class has more political power than does the labor class, it’s not difficult to see why Bernanke is backing away from his previous research on this topic.
It's All About Preferences
written by Ron Alley, April 26, 2012 6:47

It's all about preferences. Our government and, to a remarkable extent, our population prefers banksters. That Bernanke and Obama have shown far more concern for banksters than workers is entirely consistent with the history of the federal government - from the executive to the Congress to the Supreme Court - over the past 100 years or so. Meanwhile the Koch Bros. backed Tea Party zealots are more interested in regulating sexual mores than in regulating banksters or protecting consumers

You live in 21st century America. Wake up and smell the coffee.
Fearful Ben
written by Bart, April 26, 2012 6:53

I just hope Bernanke isn't holding his fire for fear of being accused of trying to help Obama's reelection. That would be criminal.
written by bakho, April 26, 2012 7:38
I can see 2 factors that would prevent the Fed from reaching a 4 percent inflation target in the near term.

1. Any stimulus or easing done by the Fed merely encourages the Austerians in the US and Europe. The Fed is fighting strong Fiscal policy (pulling in the wrong direction) with weak monetary policy. Can monetary policy alone push inflation to 4 percent inflation without help from fiscal policy? or with our current fiscal policy (especially the States) pulling in the wrong direction? Is there a danger that any new move by the Fed will simply encourage more fiscal contraction?

2. What is the mechanism that will translate Fed policy into inflation? We are in a demand slump that has created overcapacity and labor surplus. The overcapacity makes the risk premium for return on investment skyrocket. How much fear of inflation is necessary to offset the risk premium? Business will not invest in more capacity until demand for product starts to close the gap with capacity. Any business creating more capacity in a market that already has excess capacity is unlikely (in the extreme) to get return on investment. The high risk premium is why even interest rates at near zero fail to stimulate investment. How would QE affect these risk premiums if QE was not doing something to directly increase demand for goods and services? The risk premium increase (for getting return on investment) that accompanies a demand slump is the elephant in the room that is ignored. The only way to reduce the risk premium is to increase demand and reduce the gap between demand and capacity. How can other measures to stimulate investment clear the super-high risk premium barrier of overcapacity? Does the risk premium first need to be lowered by creating more demand?

On the labor side, a 4 percent inflation target really means 4 percent wage inflation. How does an economy get to 4 percent wage inflation with a Congress that refuses to increase minimum wage, refuses to create jobs, the ability of companies to outsource labor to other countries or replace labor with capital, a competition for jobs that puts downward (not upward) pressure on wages, and increasing productivity? I see little hope for much wage inflation until we are far closer to full employment.

Can Fed policy create inflation in the real estate market? How does real estate or commodity inflation help the economy if it is not accompanied by wage inflation?

We are in a demand slump. There may be indirect (Rube Goldberg) scenarios for increasing demand through better monetary policy. I think we should try everything possible including monetary policy to increase demand at this time. However, the best monetary policy is no match for bad fiscal and regulatory policy.

Bottom Line: Until we get better fiscal policy that works in concert with expansionary monetary policy (and not against it) the Fed will be impotent in attempts to create more stimulus.

-jonny bakho
written by Jabbo312, April 26, 2012 8:39
Where do they sell coffee for ten cents?
written by skeptonomist, April 26, 2012 9:14
Just a reminder that the success of the proposed increase in the inflation target depends on two unverified hypotheses; first, that anticipated inflation and interest rates are significant controlling factors in investment and spending at present; and second, that people in the real economy (as opposed to economists) actually believe that the Fed controls inflation. It seems to me that national economic policy should be based on things for which there is actual empirical evidence, and those who argue for this policy have provided none.

If the Fed could actually throw money out of helicopters as Bernanke promised at one point, this would be much more likely to have an effect. But since this is not allowed, those who continue to insist on the importance of monetary policy are reduced to extremely conjectural, indirect remedies like changing the inflation target. As Dean says, raising the target would probably do no harm, but surely economists could direct their efforts to promoting more direct things including fiscal measures.

If and when inflation actually begins to rise the terms of this debate and the pressures on the Fed will probably be very different, and it might not be politically possible for the Fed to keep any promises it may make now. I would not bet on the Fed really sticking to a given policy for a period of more than a couple of years; would you?
Where's That Coffee?
written by Frank Moraes, April 26, 2012 11:00
All true, but it would have been helpful if you had told readers where the 50 cent coffee could be found.
weird left-right fushionists say the Fed is powerless
written by Peter K., April 26, 2012 11:42
"I see little hope for much wage inflation until we are far closer to full employment. "

I think you're wrong.

"As Dean says, raising the target would probably do no harm, but surely economists could direct their efforts to promoting more direct things including fiscal measures. "

Economist "could" but it really wouldn't change anything. And don't call me Shirley.

The Fed has a dual mandate. Congress doesn't have a mandate to do anything particular. The Fed is failing at its mandate. The Congress doesn't have a mandate to fail.

Bernanke said the Fed could do more if the situation deteriorates. It's "prepared" to. Hence it could do more now if it wanted to it's just that they don't think the situation warrants it.

The bs about downside risks is just butt-covering.

the fed, what it is & what it does
written by mel in oregon, April 26, 2012 3:26
first the fed is totally controlled by financial institutions. there are 12 district banks, & by far the most influental is the new york (wallstreet) bank. basically they don't care anything about unemployment else how could bernanke have continued under obama? there sole consideration is to protect creditors, they don't care anything about debtors. the fed really is only part of the reason capitalism in america & europe is failing. it's part of a system that believes in privatizing everything, the food we eat, the air we breathe & the water we drink. if you are skeptical, you need only look at student debt, credit card debt, mortgage debt & auto loan debt. when the banks got rid of regulation Q under intense bank lobbying, the privitization of the loan business began with the resulting securitization of loans & repackaging into derivatives like cdos, & collateralized loans. when they sold the derivatives the result was all the toxic junk on the banks balance sheets. so bernanke, the head of the fed, the obama administration, the congress & the supreme court as well as romney, the wannabee all support the fed. apparently they can't figure out the road we are on is a path to destruction. meanwhile one of the bigger success stories in south america (argentina) nationalizes their oil companies. china is growing their economy at nearly 10% a year. we don't have to constantly reinvent the wheel. china has achieved such success by basically coping other countries best ideas, much as japan did decades ago. the fed is a necessary institution, but it will never work the way it is constituted today. it needs to be run by we the people not the bankers. of course that will never happen. oh well only in america....
written by Andrew Clearfield, April 26, 2012 3:53
To be fair to Bernanke: we'll need to rely on large amounts of outside funding to sustain our government for some time into the future, so the credibility of the fed as a vigilant inflation policeman is indeed very important. I still agree with you, but I think you go too far when you say: "I don't see the downside. Bernanke's obsession with the Fed's inflation fighting credibility (like the ECB's) is really pathetic. How much is this worth when you just wrecked an economy with your incompetence in protecting against asset bubbles?"
$1.37 per cup
written by BobTinKY, April 27, 2012 8:11
at the Quik Mart here. $.50 will get you only about 4/10 of a cup.
Real Inflation Rate?
written by Tom Joad, April 27, 2012 10:00
Regardless of what the government says our current inflation rate is, (2.6% I think) consumers know it is really higher.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.