Will the Fed listen to Doctor Krugman, or just drive off the nearest cliff? (re: interest rates)

[Kurt_and_Hunter]

All of Krugman's work on the Japanese lost-decade suggests that a reliable expectation of future inflation is necessary to recovery.

The central bank must essentially convince everyone that it will keep rates low even if some inflation develops so that economic actors will act on the expectation. Instead, hawks on the Fed are doing the opposite by signaling like crazy a desire to raise rates, essentially talking our economy down.

The prospect of future inflation does not help recovery if it is expected that the central bank is going to fight it in the usual way. Left to their devices, inflation hawks will pounce to strangle any sign of recovery because recovery from a deflationary environment is intrinsically inflationary.

And what's the point of propping up the dollar if doing so tamps down domestic economic recovery?

The biggest economic question we face is whether the Fed is willing to accept a surprising reality (interest rates must stay at 0% for years going forward) over 'obvious' but disastrous conventional-wisdom that rates must be raised soon because... well just because. (Raising rates is the 'serious person' position, much as invading Iraq was the 'serious person' position.)

_____________________

The madness of the monetary hawks (wonkish)

I’ve been writing about the worrying signs of hawkishness at the Fed — quite a few Fed presidents seem to be itching to tighten monetary policy, even though the economy remains deeply depressed. But just how far are we from the point at which monetary policy should start tightening?...

(snip / read the whole thing at link)

Predictions from the Survey of Professional Forecasters, say that unemployment late next year will still be only marginally lower than it is now, and core inflation will have fallen; the implied target rate for fourth quarter 2010 is around minus 5.5, barely changed from the current situation. ...By late 2011 the forecast calls for modest reductions in unemployment — but I still get a target Fed funds rate well below zero.

So where’s the case for monetary tightening? For some reason many Fed officials seem to view it as inherently unsound to stay at a zero rate for several years running — but I’m at a loss to understand what model, or even conceptual framework, leads them to that conclusion. Reading the quotes collected by Tim Duy, one gets the impression of officials who have decided that they want to tighten, and are making up new conceptual frameworks on the fly to justify their desires.

All this is very familiar: the same thing happened in Japan back in 2000. It seems to be really hard for central bankers to accept the need for prolonged easy money, even if all the data say that’s what is needed.


http://krugman.blogs.nytimes.com/2009/10/10/the-madness-of-the-monetary-hawks-wonkish/

______________________

Added on Edit--preceding Krugman blog entry: Beware the Dollar Hawks

http://krugman.blogs.nytimes.com/2009/10/09/beware-the-dollar-hawks/

[DJ13]

1. This looks like a repeat of the mistake FDR made in the mid 1930's

He and the Fed listened to the deficit hawks in the GOP and thought they could cut spending and raise rates, which just sent the shaky economy that was on the verge of a sustainable recovery right back into the depression.

[jgraz]

9. Yes, and without the success of FDR in the early 1930's

This is gonna work out well. :eyes:

[Captain Hilts]

13. 1937. Henry Morgenthau actually played an important role in talking him into a tight $ policy.

[Kurt_and_Hunter]

2. "Beware the dollar hawks"

Beware the dollar hawks

Although I poked fun at the WSJ in my last post, the buzz about the dollar — the growing clamor to do something about its decline — is coming from a number of people. And it has me worried, because it’s part of the groundswell of demands that we begin an exit strategy from loose monetary policy now now now, even though nothing in the actual economic situation warrants such action.

Ed Andrews’s article on dissension at the Fed was deeply disturbing when you bear in mind that Fed presidents historically never air such disputes in the open. The fact that they’re doing so now is an indication that many of our central bankers are so eager to start tightening that they’re throwing the normal rules aside.

This is really bad. Bear in mind that with core inflation below the Fed’s target of 2 percent (which I think is too low, but that’s another story) and huge excess capacity in the economy, the Taylor rule says that interest rates should be negative, and since they can’t, they should stay zero for a long time...

http://krugman.blogs.nytimes.com/2009/10/09/beware-the-dollar-hawks/

[Kurt_and_Hunter]

8. .

[Kurt_and_Hunter]

25. .

[bertman]

3. Thanks for posting this, Kurt_and_Hunter. I'll be back to read in depth.

[Kurt_and_Hunter]

5. You're welcome. It's an excellent pair of entries

[Kurt_and_Hunter]

4. I wish unrecc'ers would share their thinking

It is valid to unrec this or any other post, but is it animus toward Krugman, animus toward me or support for raising interest rates?

[jgraz]

10. They're sharing all the thinking they have.

* crickets * crickets * crickets * crickets * crickets *

[glitch]

21. It's animus against anything even mildly critical of Obama's actions (or inactions).

The Heathers will not tolerate attempts at discussion.

[grantcart]

6. Interesting, the "silliness of the serious person".

[Kurt_and_Hunter]

7. Serious positions seem to be a mix of obviousness and contempt

Increasing the money supply causes inflation.

We have increased the money supply more than ever before.

Thus we are going to have more inflation than ever before. QED.

The suggestive fact that bond-traders (and stock traders) are not behaving as if we will have run-away inflation is dismissable evidence because the CW hound thinks his position is a clever insider view (despite its obviousness) and is willing to believe everyone else is missing it.

And there are all those telltale clues of someone not being a 'serious person' --

Dr. Krugman's work is dismissable because he is 1) an academic (not serious), 2) a Democrat (not serious) and 3) physically unimposing (not serious).

Larry Kudlow, who has never been right about anything I know of, is Wall Street, Republican and a sharp-dressed-man. Very serious guy.

[denem]

11. Everytime I've suggested inflation is a good idea for the US economy

overburdened by debt, I've been slapped to shit with horror stories from the 1970s (Not that peak oil leaves much wiggle room).

Now that St. Krugman has endorsed a 'reliable expectation of future inflation', slap him to shit. You know you wanna.

[mkultra]

23. he isnt saying inflation is good

he is saying its unavoidable.

[Kurt_and_Hunter]

24. Yes, though he is also saying it is good (to some degree)

But we are not talking about 15% inflation. That would not be good.

We may be looking at 1% inflation next year. Most economists consider inflation that low to be below the minimum idle speed for the economy.

There's a deep indoctrinated anti-inflation bias in the public similar to our indoctrinated pro-corporate bias. Super-low inflation benefits banks most of all.

Capitalists love super-low inflation because inflation reduces the value of... idle capital!

The biggest (or, if one prefers, certainly *among* the biggest) driver of inflation (historically) is wage pressure. Super-low inflation stagnates wages as much or more than it stagnates the price of bread or housing.

[DLnyc]

12. Seems like there are those that profit from inflation and those that lose from

it.

In general, if you owe money (like myself and much of lower to middle-class US), you will find it easier to pay it off if dollars inflate and, thus, are easier to come by.

If you are OWED money (think Bank of America and other criminal outfits), you really don't like inflation, since it means your indentured slaves are going to get away with paying you back in dollars that are not quite as valuable as you like.

So, much as I admire Krugman, I think he is being a little coy in not just saying that by raising rates, bankers win and most of us lose.

Incidentally, for those middle-class friends of mine who are very proud that they've paid off their mortgages, it is true that inflation won't help them as much as others who are deep in debt (they already paid off their house in strong dollars), at least they will be protected from loss in that house prices probably go up if there is strong inflation.

[Hippo_Tron]

17. That's not entirely true

While banks get to lend at a higher rate they also have to pay higher interest on deposits when interest rates are higher. Right now they are essentially getting free money from the fed by borrowing it for next to nothing and then lending it out at a higher rate. As a result they can pay lower deposit interest rates because they have less demand for the deposits.

[DLnyc]

18. I don't think we're talking about the same issues.

Certainly short-term rates adjust to inflation, so the banks don't necessarily make more (or less) on those during periods of inflation. And, short-term, they certainly like getting cheap money to lend out (although they don't currently seem to be actually lending that cheap money out).

What I am talking about,though, is fixed-rate long-term loans, such as fixed-rate mortgages, student loans and long-term treasury and corporate bonds. If these are paid back after a good deal of inflation, I think it is fairly clear that the borrower is happier and the lender is less happy. More precisely, if the inflation is more than was anticipated (and priced into the fixed rate), then the borrower effectively pays less than originally expected and the lender gets less than originally expected.

In particular, a holder of a great deal of long-term dollar-denominated bonds (China, for example) will not be thrilled with a lot of (dollar) inflation. A young doctor, owing a couple hundred thousand in (fixed rate) student debt, on the other hand, would have an easier time paying that off if inflation raised prices (including the price of doctor visits). Banks typically have a lot of long-term fixed rate loans on their books (mortgages and business loans) so they could be expected to favor low inflation, which would tend to make their loans get repaid with more valuable dollars.

Of course, banks looking at the larger picture might see that they are better off letting things inflate a bit to avoid a complete collapse of the credit system, but usually their greed is more powerful than their planning. And, anyhow, Uncle Sam is sure to bail them out if the whole thing collapses, so why should they care?

Maybe I am missing something, but this all seems fairly straight-forward to me.

[depakid]

14. The Australian RBA just raised rates- and they're blowing it by doing so

[Yavin4]

15. The Biggest Threat Is Rapid Deflation, Not Inflation

Incomes are declining which reduces spending which causes more layoffs which means more declining incomes. It's becoming a vicious downward spiraling depression.

[Jakes Progress]

16. Why should they listen to a Noble Laureate who.....wait. Never mind.

[HamdenRice]

19. Can I remind everyone, especially Ron Paul Fed haters, that both sides accept necessity of the Fed?

It's a very difficult technical issue, and Krugman is probably right. Certainly now is not the time to raise rates, and I doubt Bernanke will. I suspect he is just signaling international dollar and t-bill investors that at some point rates will be raised to protect a catastrophic drop in the dollar.

Whichever side you come out on, though, none of this control would be possible without the Fed.

[mtnester]

20. I am guessing cliff? n/t

[Kurt_and_Hunter]

22. Magic Eight-Ball says...