Inflation, Credibility, and Expectations: Again Some More
Paul Krugman rightly attacked the confidence fairy again yesterday — claiming that the unemployment of the 80s following Volcker’s tightening proves that Fed credibility doesn’t help — but I think he misfires this time. Here’s what I sed over there, with some tweaks:
To be fair, Paul, isn’t the point here that in 1980 the Fed was decidedly lacking in inflation-fighting credibility? Volcker changed that — as you say, at great cost — and reluctance to lose the resulting credibility has been grounds for not sufficiently addressing the employment side of the Fed’s mandate ever since.
More to the point, though: I am utterly mystified why the Fed thinks that saying it will allow slightly higher inflation (3 or 4 percent), doing so, then presumably bringing it back down, would hurt its inflation-fighting credibility. Quite the contrary.
Unless: they actually believe that they couldn’t pull it off — that a wage-price spiral would ensue, destroying their credibility. Which is the same as saying “if we let things go a little now, allowing more inflation while spurring employment, we may have to allow a lot of unemployment in the future (a la Volcker) to control runaway inflation.”
Given our (their) inability to predict economic futures, and their at-least-perceived decades-long ability to control inflation without big Volcker-style employment hits, this seems like a ridiculous concern.
The more likely explanation in my view: each extra point of inflation would transfer hundreds of billions of dollars of buying power every year from creditors to debtors. Permanently. This isn’t just Econ 101; it’s simple arithmetic.
And the Fed is run by creditors.
This explanation is completely in keeping with the rightie mantra that (only personal financial) incentives matter.
This raises a question I have, especially for (Market) Monetarists:
Suppose two or three years from now inflation is at 4% and employment is strong. Could the Fed bring inflation down by saying they’re going to be less expansive — setting expectations for lower inflation? Or is expectations-setting asymmetrical?
Can the Fed set higher expectations for growth/inflation largely through Open Mouth Operations, while lowering expectations would require (more) actual monetary operations, Volcker-style?
Cross-posted at Asymptosis.
Amen. Preach it brother er rather ask it. We know the Fed can’t reduce inflation expectations just by open mouth operations, so why is it supposed to work the other way ?
Also why didn’t I think of calling them open mouth operations?
“Open mouth operations”
Well put, sir! 🙂
I should have given credit for that OMO usage, saw it on a blog the other day, can’t remember where. But now I see it’s quite widespread — 185K hits on Google, even has its own investopedia entry.
“Could the Fed bring inflation down by saying they’re going to be less expansive — setting expectations for lower inflation? Or is expectations-setting asymmetrical?”
I don’t know, but hey, let’s give it a try and see what happens. Can’t be worse for the 99% than now with no wage competition to drive prices do to weak labor power. Or are they suddenly expecting that because of inflation labor will get an upper hand.
I recall everytime during the 90’s when it looked like labor was going to get some of the productivity gains, Greenspan cranked the rate up and that ended that labor dream.
Inflate what? More and more for 20 years persistent low interest rates and the expansion of its balance sheet have lead mostly in inflation of assets, mainly financial, and in fits and starts, commodites. The structure of the economy and mechanisms of monetary policy now ordain that inflation will remain in those areas but where and when exactly is always unknowable. Everyone is happy when it is financial assets inflating but do you recall $148 oil or more recent $115 which had an obvious speculative basis. Do tell, how did that help the economy.
Do yourself a favor. When QE3 is announced wait two weeks and start buying stocks and commodites. One can I suppose too wait for the golden results of general inflation in the real people real jobs economy. An exercise in futility.
Oh, one other thing. The most inflated thing in the world now is US Treasury debt. At some point if real commodity inflation takes hold, along with other select goods, they will start to deflate and they its game over for the Fed, and they know it.