Up, Up and Away (Again)

October 17, 2010

by Bill Butos

Federal Reserve Chairman Ben Bernanke is pushing for another significant round of “quantitative easing” – now dubbed “QE2” by Fed observers – on the grounds that the economy’s response to simulative macro policies since 2008 has been anemic.  What the economy needs, this thinking goes, is some inflation.  While much of the public sees the run-up of  growth in government and exploding deficits as keys concerns, Bernanke,  continuing his soft stance on deficits, has argued that fiscal restraint would threaten the recovery.   Instead, he argues that monetary policy still has arrows in its quiver that should be used to lower the unemployment rate and rejuvenate the economy while also preempting the dreaded prospect of deflation . 

Chairman Bernanke’s  October 15 speech  on “Monetary Policy Objectives and Tools in a Low-Inflation Environment” at the Boston Fed Conference argues that deflation will seriously handicap implementing countercyclical monetary policy given the zero bound on nominal short term rates.   The Fed’s current (and implicit) inflation target of 2% is meant to ensure adequate maneuverability for Fed discretionary monetary policy.  (Why we need monetary policy or a central bank at all is a topic for another day.)   And according to some insiders, Bernanke and his supporters in and beyond the Fed seek an inflation rate in the 4-6% range for just “a couple of years” (see Allen Mattich.).  

The Fed believes that QE2, which would involve massive purchases of Treasuries, would push yields on Treasuries and bonds down and produce a surge in investment and consumption expenditures.  Yet, this assumes that the economy’s recovery has been retarded by insufficient aggregate demand – much like a flat tire – but which ignores the well-documented effects and uncertainties of existing and prospective government policies themselves on decisions at the market-level.   Within this milieu, if nothing else, the Fed’s inflationist  moves will mask and circumvent the very micro adjustments necessary for economic recovery.  Given the one trillion dollars of excess reserves currently held in the banking sector, the widening call for outright inflationist policies is an alarming, but probably predictable, development in Washington.  As Allen Mattich writes:

“In other words, the thinking goes, if the Fed could return the U.S. economy to the activity levels of the 1970s, even if that means 1970s-style inflation and consequent recession, that would be less bad than years of 1930s-style shortfalls in aggregate demand.  And this is probably what the Fed is thinking as well.”

Government intervention gave us this recession and government policies have unnecessarily prolonged and intensified the pain.  Now, Federal Reserve inflationary policies are apparently poised to sweep us up, up, and away until, that is, the balloon bursts once again.

24 Responses to “Up, Up and Away (Again)”


  1. Bill Butos has got this right. The Bernanke Fed wants inflation and intends to deliver it.

    There are some Fed officials hoping to reflate the housing markets. If not that, then the stock market. The hope there is get a wealth effect to kick in.

    In the FT, Martin Wolf sees the Fed policy as the opening round in a global currency war. The Chinese won’t appreciate the Yuan, so the Fed will sink the dollar. So who is the currency manipulator?

  2. Bill Stepp Says:

    Right on. Robert Mundell was interviewed in the weekend WSJ and mentioned that the rising price of gold is a good barometer of inflationary expectations. The dollar has also continued to slide against other currencies. (Mundell favors fixed exchange rates, unlike Milton Friedman.) The Economist also discusses “currency wars” this week, but thinks they will be headed off at the pass.

  3. Mario Rizzo Says:

    I am not sure what Bernanke (or his interpreters) are thinking. The Financial Times reported on Friday, Oct.15th:

    “US inflation expectations for the next 10 years also continued to climb, reaching 2.09 per cent, up from 1.90 per cent in the past week.”

    http://www.ft.com/cms/s/0/5505a7f0-d7c2-11df-b478-00144feabdc0.html

    So does the Fed want even more????


  4. Mario asks a good question.

    Bernanke complained that inflation is too low, staying below 2%. The Fed has never officially set an inflation target, but it is widely believed to want inflation to stay in the 0-2% range. As Allan Meltzer pointed out recently, the inflation rate has not fallen out of the target range.

    I’m hearing talk of 4%+. The Fed doesn’t have the ability to move inflation up to that figure and then hold it there. So watch out.

    Here is a sobbering statistic from John Taylor. To return debt burdens to 2008 levels, inflation would need to average 10% for 10 years.

    Put the numbers together and make a guess. Yours is as good as mine.

  5. chidemkurdas Says:

    It has a new name — “monetizing federal debt” — but the idea is ancient, of course. It used to be called debasing the currency and took the form of minting coins with less metal. Then came fiat money so now they don’t have to worry about any metal and can debauch the currency at will.

  6. Mario Rizzo Says:

    Things are getting even more confusing. In the Oct. 16/17 iss ue of the Financial Times it is reported that Bernanke is close to going with the 2% inflation target — as if inflationary expectations were not aleady there. But then in the Oct. 18 issue the FT reports that some senior Fed officials object to this inflation targeting — at least in an explicit way. So where are we? Speaking of uncertainty…

  7. butos Says:

    The Fed’s (implicit) inflation target of 2% (which the Fed defines as the “core” inflation rate as measured by the CPI less fuel and food) combined with the near zero Fed Funds rate implies a negative 2 real rate. Even if the Fed targets the funds rate at, say, 5% – which is very unlikely in the current environment- that would imply that a real rate of only 3%. Does anyone believe that that such real rates are in any sense consistent with underlying time preferences?

    Also, as Jerry and Mario note, there is not persuasive evidence of deflation and the 1-2% inflation rate, and which, by the way,reflects the (necessary) price declines in the housing market. To say there we’re in a “deflationary economy” is, I think, largely scare tactics.

    I do think the Fed’s desired inflatiion rate has less to do with economic fundamentals and more to do with justifying the operational flexibility of monetary policy to keep nominal (and real) rates below equilibrium levels. As Jerry notes, one way to increase that flexibility would be raise the targeted inflation rate, in which case nominal rates well above above zero still result in real rates well below reasonable estimates of equilibrium values.

  8. Mario Rizzo Says:

    Let me add: Rep. Barney Frank is AGAINST inflation-targets. He says that this might make the Fed more concerned about controlling inflation than promoting growth. I assume what this means is that he doesn’t want the Fed to limit itself to just a little inflation.

  9. Lee Kelly Says:

    I don’t want to defend the Fed or Bernanke, because, in my opinion, inflation targets are not such a good idea. But I am inclined to defend a second round of quantitative easing, because I believe aggregate demand really is too low.

    Even by the standards of nominal income stabilisation, which Hayek explicitly endorsed in the 70s, aggregate demand is too low. Given expectations of rising nominal income created by the last couple of decades, the deficit is greater still.

    That said, if the Fed is serious about QE2, and the market takes the Fed’s stated goals seriously, then little quantitative easing should be needed. The first round of quantitative easing should have been quite enough, but it didn’t stabilise long term nominal income expectations, because the market bet the increase in the base would just be temporary. This sterilised much of the so-called “stimulus” — not to mention the policy of paying interest on excess reserves!

    In any case, while the uncertainties created by existing and prospective government policies and interventions are a genuine problem, monetary policy should be blind to such considerations and merely aim to stabilise nominal income (or better yet, stabilise the growth of nominal income). The uncertainties may change the composition of nominal spending and relative prices, but they should not impact the aggregate.

  10. Joe Calhoun Says:

    In his speech last Friday, Bernanke said:

    “In particular, consumer spending has been inhibited by the painfully slow recovery in the labor market, which has restrained growth in wage income and has raised uncertainty about job security and employment prospects.”

    And yet, retail sales, which just happened to be reported that morning, showed an increase of over 7% year over year.

    He also said the following about business spending:

    “Although the pace of recovery has slowed in recent months and is likely to continue to be fairly modest in the near term, the preconditions for a pickup in growth next year remain in place.

    ……

    Similarly, business investment in equipment and software should grow at a reasonably rapid pace next year, driven by rising sales, an ongoing need to replace obsolete or worn-out equipment, strong corporate balance sheets, and low financing costs.”

    So, why exactly do we need another round of QE? Based on the metrics Bernanke cited – consumption and investment – there seems no case for further action by the Fed. It is only about the unemployment rate which means to me that this new experiment in inflation is a function of political influence. Bernanke also addressed that in his speech:

    “The topic of this conference–the formulation and conduct of monetary policy in a low-inflation environment–is timely indeed. From the late 1960s until a decade or so ago, bringing inflation under control was viewed as the greatest challenge facing central banks around the world. Through the application of improved policy frameworks, involving both greater transparency and increased independence from short-term political influences, as well as through continued focus and persistence, central banks have largely achieved that goal.”

    Through his actions Bernanke proves that political influence is alive and well.

    And if QE II is “successful” it will raise inflation expectations and it should raise nominal bond yields too. If inflation expectations rise now, bond yields shouldn’t be far behind. Any stimulative effects of QE II will not come from lower rates. Take a look at QE I; rates fell initially and then rose 150 basis points in the next few months (using the ten year treasury).

    We’ve already seen a rise in commodity prices just on the rumors of QE II. I doubt that higher oil and other raw materials prices will provide much stimulus for the US economy so where does the stimulus come from? I suspect that Bernanke is looking to stimulate demand in Asia and Latin America and through a lower dollar increase US exports.

  11. Joe Calhoun Says:

    In his speech last Friday, Bernanke said:

    “In particular, consumer spending has been inhibited by the painfully slow recovery in the labor market, which has restrained growth in wage income and has raised uncertainty about job security and employment prospects.”

    And yet, retail sales, which just happened to be reported that morning, showed an increase of over 7% year over year.

    He also said the following about business spending:

    “Although the pace of recovery has slowed in recent months and is likely to continue to be fairly modest in the near term, the preconditions for a pickup in growth next year remain in place.

    ……

    Similarly, business investment in equipment and software should grow at a reasonably rapid pace next year, driven by rising sales, an ongoing need to replace obsolete or worn-out equipment, strong corporate balance sheets, and low financing costs.”

    So, why exactly do we need another round of QE? Based on the metrics Bernanke cited – consumption and investment – there seems no case for further action by the Fed. It is only about the unemployment rate which means to me that this new experiment in inflation is a function of political influence. Bernanke also addressed that in his speech:

    “The topic of this conference–the formulation and conduct of monetary policy in a low-inflation environment–is timely indeed. From the late 1960s until a decade or so ago, bringing inflation under control was viewed as the greatest challenge facing central banks around the world. Through the application of improved policy frameworks, involving both greater transparency and increased independence from short-term political influences, as well as through continued focus and persistence, central banks have largely achieved that goal.”

    Through his actions Bernanke proves that political influence is alive and well.

    And if QE II is “successful” it will raise inflation expectations and it should raise nominal bond yields too. If inflation expectations rise now, bond yields shouldn’t be far behind. Any stimulative effects of QE II will not come from lower rates. Take a look at QE I; rates fell initially and then rose 150 basis points in the next few months (using the ten year treasury).

    We’ve already seen a rise in commodity prices just on the rumors of QE II. I doubt that higher oil and other raw materials prices will prove stimulative for the US economy so where does the stimulus come from? I suspect that Bernanke is looking to stimulate demand in Asia and Latin America and through a lower dollar increase US exports. It won’t work but that seems to be the game.

  12. chidemkurdas Says:

    There is the question of how to read a central banker’s lips. Is he saying what he thinks or what he wants the world to believe? Do you take his words literally or try to read between the lines?


  13. @Chidem

    And are the words his?

  14. chidemkurdas Says:

    Great question, Jerry. And leads to others, like if some of his statements are not his, whose words are they?

  15. janet westling Says:

    Your last comment about Government intervention caused the recession has me wondering: What intervention caused the recession? Was it intervention by government that made the securities worthless, or something the traders were doing? This is related. The cause is an important factor for finding a solution.

  16. Chris Evans Says:

    All this theorizing about QE2 is something Main Street don’t care about. The “theory” will always sound “sound” but it doesn’t mean that it will allow for all the real world factors that come into play. “Inflation to force/increase spending because it’s futile to invest/save” is an idea but where does the “idea” no money to spend because there’s no job/opportunities come in?

  17. Richard Says:

    Isn’t the buying up of bonds with more printed money just the sort of thing that got post War I Germany in trouble?

  18. Dada Says:

    Does all these money printing constitute legally robbing your citizens and neighboring countries?

  19. Christan Smith Says:

    That is why Bill Butos is a “guest blogger” and NOT not an Economist, as he could not be more inaccurate with his conclusions. Word to the the wise, stick to what you know.

  20. KenP Says:

    Any way you look at it, they will scald, pluck, and fry the middle to lower income folks.

  21. Bill Johnston Says:

    Macro-Micro Economics. What a sophistcated way to use government intervention to re-define markets and property rights. The belief that political electorate knows what is best for each (micro), and all(macro) of us. The basic Keynesian beliefs that individuals do not know what is in their own self interest. They say self interest is contrary to the well being of the whole and only ‘they’ should direct policy. What is best for everyone must be defined by the intellenencia who knows what is best for everyone. Combine fuzzy logic with junk science and you have the recipe for economic disaster.

  22. Kerry Jessen Says:

    This is insane! Bernanke needs to retire. If you look at history, “deflation” is not always a bad thing, and often a very necessary thing. Printing more money will never, ever heal this economy in today’s global market. It’s like putting a bandaid on a volcano.

  23. Trudy Says:

    If you have no money….like main street, the fed can raise inflation but no amount of ‘raising prices’ will get us to buy. Bernanke needs to be ‘let go’ in ‘shame’ and we need to CAP corporations earnings… I know, I know…

  24. John Steinsvold Says:

    An Alternative to Capitalism (which we obviously need here in the USA)

    Several decades ago, Margaret Thatcher claimed: “There is no alternative”. She was referring to capitalism. Today, this negative attitude still persists.

    I would like to offer an alternative to capitalism for the American people to consider. Please click on the following link. It will take you to an essay titled: “Home of the Brave?” which was published by the Athenaeum Library of Philosophy:

    http://evans-experientialism.freewebspace.com/steinsvold.htm

    John Steinsvold


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