Hedgehog Paul Krugman’s advice is almost precisely the opposite of Kevin Warsh’s:
We’ve already seen this happen with fiscal policy: fearing opposition in Congress, the Obama administration offered an inadequate plan, only to see the plan weakened further in the Senate. In the end, the small rise in federal spending was effectively offset by cuts at the state and local level, so that there was no real stimulus to the economy.
Now the same thing is happening to monetary policy.
The case for a more expansionary policy by the Fed is overwhelming. Unemployment is disastrously high, while U.S. inflation data over the past few years almost perfectly match the early stages of Japan’s relentless slide into corrosive deflation.
Unfortunately, conventional monetary policy is no longer available: the short-term interest rates the Fed normally targets are already close to zero. So the Fed is shifting from its usual policy of buying only short-term debt, and is now buying long-term debt — a policy generally referred to as “quantitative easing.†(Why? Don’t ask.)
Just as I would be more enthusiastic for Dr. Krugman’s proposal for counter-cyclical Keynesian spending if he were to accompany it with his proposals for pro-cyclical real spending reductions, I would be more enthusiastic about the prospect of a higher inflation target if he could explain how we would cope with a collapse of the dollar should one occur. History suggests that the speed with which ordinary inflation may turn into hyperinflation is alarming, faster by far than the ability of policy makers to act.
I’m struggling to come up with a hyperinflation scenario where our debt is denominated in our currency and there’s no recovery. Before wages go up, we have a lot of labor on the sidelines in both unemployed and underemployed situations that can keep wages down. Can you have hyperinflation without a wage/price spiral? I think a more realistic scenario is a sawtooth recovery where high inflation expectations drive commodity prices up causing mini-recessions until they fall again.
I think the bit about state cutbacks equaling expansion in federal spending, if mathematically true, is a big problem for stimulus critics.
I’ve always preferred (what I think of as) genuine counter-cyclical spending, in part because I believe there is a non-zero multiplier.
If state contraction equaled federal expansion, what are we multiplying?
(Certainly if we shed good state spending for bad federal spending, it was an uneven trade.)
My (tentative) view is that exploiting the Keynesian multiplier is possible with carefully crafted and timed federal spending. I’m skeptical that the Congress is capable of that sort of care and celerity.
sam –
Inflation is always, and everywhere, a monetary phenomenon. Velocity will recover at some point. If you’ve got a stash of cash you should be monitoring this very carefully.
Drew –
In other words, a recovery? After which we will see interest rates rise and all the other more conventional tools the Fed has to decrease it. I think if you didn’t have this expectation the Fed wouldn’t be doing it’s job properly.
Short of my emergency fund I don’t have a lot in cash. I do have a large fixed interest mortgage which I wouldn’t mind seeing shrunk in real terms and real estate which I’d love to see worth more than I paid for it. A major portion of my company’s revenue is from exports so I wouldn’t mind seeing it get more competitively priced either.
I’d say that to the degree all prices move in correlation, you might be seeing monetary inflation. I think it’s been a long time since we’ve seen that. We are left to ferret which price signals might signal a reaction to money supply.
Some argue that commodities prices have been showing real inflation in response to an increased money supply … really since the first stimulus. Or since the start of the gold rally, if you prefer.
If house prices take another decline I’ll be better off, net-net. That’s because I’m more buyer than seller right now, and my personal CPI would have a house purchase as a major contributor.
sam –
More specifically, bank lending. That may, or may not, correlate with a recovery.
“I do have a large fixed interest mortgage which I wouldn’t mind seeing shrunk in real terms”
As do all debtors.
” and real estate which I’d love to see worth more than I paid for it.”
Good luck.
“A major portion of my company’s revenue is from exports so I wouldn’t mind seeing it get more competitively priced either.”
I understand your interests, but they are narrow self interests, that may not be in the interest of the general business environment and population.
One of the major problems with pushing the dollar lower as a tactic for increasing exports is that very, very few U. S. exporters derive everything they use, e.g. raw materials, components, etc. domestically or have contracts with both vendors and customers denominated completely in dollars.
Driving costs up while you drive sales up isn’t much of a solution.
What driving the dollar down does do is reduce retail sales in the U. S. That’s bound to cause dislocation which is part of what we’re seeing right now. I suspect we’ll see a lot more of it in coming months.
Driving the dollar down can also create commodities bubbles. And it can provoke retaliation creating a situation in which all of our competitors are driving their own currencies down as fast as their little legs can carry them.
Not much of a tactic.
Our expenses are about 95% labor and real estate, but I see your larger point. The point I was originally making was that I don’t see the wage side of a wage / price spiral for hyperinflation. Commodities prices will come down again when no one makes enough money to buy anything and stockpiles grow. I’m not dismissing the bubble idea – I’m saying that they likely will happen but be small and short lived until we are actually in a self sustained recovery at which point the Fed will claim success.
I thought that was the whole point – that there’s not enough of this and the lack of velocity was having the equivalent effect of tightening the money supply?