Hey all.
Terribly sorry for the delay in posts, but I'm currently working on buying some new property (remember, all aspiring economists, it's now a buyers market out there!).
So to whet your appetite for economic discourse, here's something that's always been bothering me;
Monetary policy.
Monetary policy was never a strength of mine, but I’m finding it harder and harder to see why it’s so difficult.
Will somebody please tell me why we have a target inflation rate of 2% and not 0%? And I know that if we get inflation of 0% the deflationary fighters’ fear/argument is that, "we could fall into deflation which would have the same misallocation/wealth redistribution effects and problems inflation has except in reverse."
So what?
It would seem to me deflation is the easiest thing to fight and politically beneficial;
PRINT MONEY.
Japan had been staving off deflation for years, most recently by printing money and this was actually heralded as "genius monetary policy" in The Economist no less.
Like to think I’m missing some gapping thing here, but I just can't see it.
Any central bankers out there?
9 comments:
Why go for 2% in stead of 0%? Because it is A) more convenient, and B) more credible. It is convenient because people have been trained to expect inflation. It is also useful. Take the minimum wage. Most economists believe that it is a bad idea. If we allow inflation, the economic mistakes of populist politicians are slowly washed up in the declining value of that wage. Secondly, I can only imagine the horror of every investor at hearing the Fed shoot for 0% inflation; the recession (depression!?!) would not be worth it, even if it is achievable.
The inflation target isn't 0% because governments benefit from inflation.
They want it to be low so people don't complain about it, but they want it to be positive because inflation pumps up tax revenues from capital gains.
And that's just if you're thinking clearly. If you're thinking like a politician instead, you realize you can use inflation to bribe various constituencies to vote for you.
Didnt think you were a keynesian? Maybe you should change your name to Captain Commie then..
From wikipedia and with my (an economist) stamp of approval
Until the 1930s, it was commonly believed by economists that deflation would cure itself. As prices decreased, demand would naturally increase and the economic system would correct itself without outside intervention.
This view was challenged in the 1930s during the Great Depression. Keynesian economists argued that the economic system was not self correcting with respect to deflation and that governments and central banks had to take active measures to boost demand through tax cuts or increases in government spending. Reserve requirements from the central bank were high and the central bank could then have effectively increased money supply by simply reducing the reserve requirements and through "open" market operations (e.g., buying treasury bonds for cash) to offset the reduction of money supply in the private sectors due to the collapse of credit (credit is a form of money).
With the rise of monetarist ideas, the focus in fighting deflation was put on expanding demand by lowering interest rates (i.e., reducing the "cost" of money). This view has received a setback in light of the failure of accommodative policies in both Japan and the US to spur demand after stock market shocks in the early 1990s and in 2000 - 2002, respectively. Economists now worry about the (inflationary) impact of monetary policies on asset prices. Sustained low real rates can be the direct cause of higher asset prices and excessive debt accumulation. Therefore lowering rates may prove only a temporarily palliative, leading to the aggravation of a(n eventual) future debt deflation crisis.
I don't think that it's so easy to prevent deflation if you're constantly targeting 0%. Japan has had a zero percent interest rate for five years and printed large amounts of money, but they still have had many years of deflation.
It has probably something to do with the behaviour of human beings. If prices start to fall only for 0.2%, people will begin to panic. It's the same with the inflationary process: People don't trust their Fed, especially since Mr. Greenspan departed.
Furthermore, it seems that a little bit of deflation has a more severe impact on the economy than a little bit of inflation. Although I'm not quite sure about this. I think the depression of late 19th century (high deflation) didn't hurt the economy after all, did it?
As I understand it:
Step 1) run up huge debts
Step 2) sell bonds to finance it
Step 3) inflate the money supply to pay back those debts with increasingly worthless currency
Step 4) Introduce the Reichsmark.
You can't print money without incurring inflation - even to the extent that you think you're combatting deflation.
If you've got a stable money supply, the long-run trends ought to indicate that the price-level will be declining over time, as it did in the hundred and fifty years before the advent of the Federal Reserve in 1913.
Anonymous claims that the recession incurrec by a 0% inflation wouldn't be worth it. Well, some theorists will argue that you can't continue to inflate - you can't continue to reduce the values of annuities, depriving people on fixed incomes to the benefit of those on government payrolls and in government's pocket. Inflation is a hidden tax levied on pretty much all of us.
Inflation force money into investing insead of sitting in your safety deposit box or hidding under your bed.
I think it has something to do with Bernanke being a fan of Irving Fisher.
Fisher thought deflation was the worst thing in the world (probably because he had such huge debts) and it seems to have rubbed off on Bernanke. If you (bother to) read his book on the great depression, I think he explains it there.
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