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Home Publications Blogs Beat the Press What Is the Fed's Credibility as Inflation Fighting Central Bank Worth?

What Is the Fed's Credibility as Inflation Fighting Central Bank Worth?

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Wednesday, 26 March 2014 08:37

That's the question that readers of Fivethirtyeight Economics are asking after reading a discussion of the choices facing the Federal Reserve Board. The piece told readers that the Fed could push unemployment rate down to levels where inflation began to accelerate (overshooting):

"Overshooting is risky. The Fed would risk its credibility as an inflation-fighting central bank."

The cost of keeping the unemployment rate up is that the government (through the Fed) is denying millions of people the opportunity to get jobs. The government is also putting downward pressure on the wages of the bottom half of the workforce, since their wages are especially sensitive to the unemployment rate. And the economy is losing hundreds of billions of dollars a year in lost output, since these workers could be productively employed. 

Obviously Fivethirtyeight attaches great value to the Fed's credibility as an inflation-fighting central bank since it thinks that we might think this value exceeds the costs of keeping the unemployment rate high. It would be helpful to readers if it explained how high this value is and how it came to this assessment.

Comments (13)Add Comment
They don't need the government
written by Dave, March 26, 2014 10:02
The bond mutual funds have made it more advantageous to lend to anyone except the US government. Shadow banking has won. Tear it down now or the US government will collapse.
...
written by Alex Bollinger, March 26, 2014 10:35
538 facts, 0 point.

Does the 538.com writer think we're at/near potential GDP or not? Does he think that monetary policy should be expansive or contractionary at this point?
We need to be more direct
written by Dave, March 26, 2014 10:49
The top economists needs to become more willing to explain in plain terms why the central bank has to guarantee that the US government is the preferred source of bonds. You need to make it clear the smart people in finance that if we allow this designation to erode, that the US government will collapse. That our democracy will be dead. At that time, opportunistic dictators like the Kochs can slip in and take over. They can eliminate the minimum wage and food stamps. They can set up labor camps. Eventually, most likely, many will die of starvation. It is a very real possibility.

Perhaps this sounds to apocalyptic for public consumption. Then dial it back by saying that we'll lose or vote. We'll lose our democracy.

It seems pretty clear to me that US government will fall unless it can confront and dominate Wall Street. There's not necessarily an evil hedge fund overseer that is planning this, but the Koch brothers and their friends are poised to install their preferred person as the dictator of such a new government.
Mathematics
written by Dave, March 26, 2014 10:53
It is really a mathematically inescapable fate for our system. Unless the people running the system favor political stability over higher yields, political stability will end.

I say this now because I'm really just fully realizing how close we are to losing it.

If you want to restore credibility for the central bank to create inflation, if you believe this is the vital thing that makes the system work, then you need to begin printing cash money and mailing checks to people. The inflation caused by that will be credible and potent. It will eventually work. Guaranteed. So if credibility is what the Fed desires, it needs to be potent enough to convince everyone, not just ignorant people.
...
written by skeptonomist, March 26, 2014 11:00
The Fed started cutting federal funds rate in August 2007 and it reached essentially zero by November 2008. It began QE in early 2009 and now has over $4T in assets. Has this all-out activity for over five years controlled unemployment? The last time there were major factors causing inflation, in the 70's and 80's, the Fed failed to control inflation. There was a minor blip in inflation in 2008, but the Fed had nothing to do with controlling that - when this happened the Fed was still in the process of cutting federal funds, and inflation collapsed when oil price collapsed.

The Fed has done nothing to inspire credibility in its ability to control either inflation or unemployment. Most of the discussion about this credibility is a fantasy in the minds of economists.
of course
written by Joe, March 26, 2014 11:30
of course the Fed really can't do much about unemployment. We need fiscal policy for that. Yeah I know, threaten inflation, blah blah, go worship the confidence fairy a bit..
Demographics Be Damned
written by Larry Signor, March 26, 2014 12:36
Andrew Flowers and Ben Casselman at 538 both seem sold on the idea of a declining work force due to demographics. This is wrong for at least three reasons:

1. No one is paying attention to the fore end demographic changes...~1.5 million new work force participants/year.
2. Old farts like me are not retiring en masse...we can't afford to. We are working longer in order to survive.
3. Immigration still occurs and creates an unknown amount of slack in the job market...due to an ineffectual stimulus effort by the Treasury and the FED.
(note: this is not a criticism on immigration which in more normal economic times would buoy our economy. I am solidly criticizing policy.)

If 538 is to yield us valuable insights, they will need some intellectual realignment.
Subliminal seduction
written by Jim Hannley, March 26, 2014 4:59
Glad you're on the job, Dean. Readers often miss statements that are designed to change our viewpoint without us noticing. Whether it is intentionally subversive or not, the result is that the reader accepts that "(the Fed is)an inflation fighting central bank". This statement presupposes that it has an equal mandate and that is to create as much full employment as possible. We all know that it's mission has been hijacked by those who stand to lose the most from inflation: those who own the most capital. Their chief concern is that the Fed controls inflation; the jobless takes the hindmost.
It's beginning to appear that ...
written by John Puma, March 27, 2014 1:17
538 is no more than a training ground for the next generation of Wills, Brooks's and Steyns.

The Myth of the Inflation Rate
written by jonny bakho, March 27, 2014 7:01
The percent inflation or percent inflation target has little effect on whether runaway inflation could take hold. An economy that is inflating at 4-6 percent is no more likely to have runaway inflation than an economy that is inflating at less than 2 percent. Many people believe the myth that a higher base inflation rate means more likely to have runaway inflation. That is a myth.

Runaway inflation (Zimbabwe) has two characteristics,
a high risk that the currency will not be accepted
and strong labor position to demand wage increase.

Neither is true in the US in 2014.

Inflation is necessary to reset relative prices. After big shocks, (price instability) higher inflation is needed to allow prices to reset upward. By capping inflation at a too low rate, the Fed is mandating that to reset, wage and a lot of prices need to deflate. Wage inflation is never a good thing and one reason why the 2 percent inflation target is so wrong. We need wage inflation much higher than 2 percent.
Correction: Wage DEFLATION is never good.
written by jonny bakho, March 27, 2014 7:50

Wage Deflation is never good (darn autocorrect). Wages are sticky downward. Wage deflation occurs through higher unemployment and underemployment, people working jobs that pay less than their skill level. Wage deflation increases debt default and other drags on an economy. It is far better to have inflation high enough to allow wages to reset upward.

Actions that depend on inflation (student loans, a lot of housing loans) become problematic with wage deflation. With sufficient wage inflation, loans can be paid in deflated dollars. Someone who accepted loans and planned on wage inflation may be screwed if wages deflate. In 2009, Median wages deflated. Big Problem that the Fed shrugged off. It was a warning sign that the inflation target is too low. Wage deflation should never happen.
The Sticky Direction
written by Larry Signor, March 27, 2014 9:20
We hear a lot of analysis of wage stickiness, i.e. downward stickiness. I would propose that wages are even more sticky in an upward direction, else why do we have only ~1.5% inflation? The stickiness fight is currently being won by management.
favoring unemployment
written by layofflist, March 29, 2014 10:20
The fed is in a position that favors unemployment at higher rates, since that keeps inflation tamed. If there was 'real' full employment, then inflation would be much 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.

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