Today in "Economists Are NOT Totally Clueless" (Interlude; Part 2 of 3 or 4)

Tyler Cowen can count:

In sum, maybe three percent expected inflation conflicts with the desire to rapidly recapitalize banks through maintaining a wide interest rate spread. Maybe we need that zero nominal short rate or at least the Fed thinks we do….

I also regard this as a somewhat gruesome hypothesis. It means that “Main Street” is paying for “Wall Street” (forgive me the use of those awful terms) in at least two ways: high unemployment and inability to earn much on one’s savings….

The term structure also implies that the market is expecting rising short rates, so if the bank mess isn’t cleaned up soon, heaven forbid. The spread, as a means of restoring bank profitability, won’t last forever.

And Ryan Avent (via Brad DeLong) points out the next piece of that puzzle:

[T]he Fed’s commitment to undo its interventions is already having an effect. In expectation of more of these moves to come (as well as, perhaps, increases in interest rates) markets have been bidding up the dollar, which has busily appreciated during the month of December. That, in turn, will deprive the American economy of a potential source of demand—growth in consumption of American exports thanks to the effect of a weak dollar.

More bluntly, we’re seeing a move toward contractionary monetary policy at a time when unemployment is at 10%. Funny that.

I can’t think of a scarier way to end the year. Sorry about that. Best wishes for 2010—we’re all going to need them.

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