The Economist recommends taking the easy path to inflation. But what if it’s closed?

Summary:  If the great monetary experiments underway in Japan and America succeed, then the world will change. Aggressive fiscal and monetary stimulus will become routine, even normal. For better or worse. Already the normalization process has begun by people unaware that in this new century the easy path to inflation has been closed, with as yet unknown consequences.

Money whirlpool
Christian Science Monitor, 8 November 2010

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Contents

  1. The world has changed, yet they still dream of monetary magic
  2. About inflation
  3. The Boomers’ secret lust for inflation
  4. For more information

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(1)  The world has changed, yet they still dream of monetary magic

QE3 will raise the Federal Reserve’s assets by almost 40% in its first year. Japan has adopted an even bolder strategy. One of the two arrows of the three arrows to Abenomics is doubling the money supply in two years in order to raise inflation to 2%. If these monetary experiments work, then the world will change. Already the yearnings for inflation, simmering since the crash (but expressed in euphemisms), are now expressed openly.

Secular stagnation: The second best solution“, The Economist, 21 January 2014  — Excerpt:

WITH a string of talks and op-ed columns, Larry Summers has revived discussion in the “secular stagnation” hypothesis. Income has become concentrated in the hands of groups, like reserve-accumulating foreign governments and the rich, with low propensities to consume, the thinking goes. That has generated excess saving and pushed down real interest rates until they are substantially negative at many durations. That, in turn, has made life very difficult for central banks, which have struggled to stoke up adequate demand with nominal interest rates wedged up against zero.

Mr Summers identifies three broad solutions to the problem.

  • One is to do nothing, or not much anyway, on the demand side. This is not a particularly attractive solution, as it implies a very long slump in which incomes are lower than they need to be, unemployment is higher, and the economy’s potential is eroding.
  • Another is to raise inflation expectations in order to reduce real, or inflation-adjusted, interest rates until demand is where we’d like it to be. This policy is not without its downsides …
  • The last option to address stagnation is to have the government soak up excess savings and boost demand through deficit-financed public investment.

The third option is quite clearly Mr Summers’ preferred course of action. And it is a very attractive option. It is a rare rich country that doesn’t have a list of infrastructure needs that could justifiably be addressed in the best of times. Pulling those off the shelf and taking them on amid rock-bottom interest rates and weak demand is a no-brainer. Unfortunately, governments are discinclined to seize these opportunities. That makes it very important to sort out the relative attractiveness of alternative solutions to stagnation.

My sense is that Mr Summers reckons the inflation strategy is not as easy to deploy successfully as I make it out to be. QE purchases focused on safe assets might have an ambiguous effect on the economy: boosting asset prices through portfolio balance effects but limiting lending growth by sucking up the supply of good collateral. And as Brad DeLong notes, high inflation could conceivably undermine the safe-asset status of some government securities. Meanwhile, central banks might not be comfortable mustering the bluster to convince markets that higher inflation is ahead. And if they did, increases in long nominal rates could create their own financial difficulties.

US dollar

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So there we are. I’m not convinced of the seriousness of some of these challenges. A fiscal stimulus that succeeded in creating adequate demand would also generate big increases in long-run nominal rates, for instance. If higher inflation primarily works as a solution to stagnation because it redistributes purchasing power from savers to spenders, then financial stability concerns are almost certainly overstated. I think we make a mistake in worrying about the technical difficulty of using either fiscal or monetary policy to whip stagnation.

But I should also acknowledge a weakness in my own argument. I often return to higher inflation as a strategy because something like Mr Summers’ five-year programme of deficit-financed public investment looks politically unachievable to me. Higher inflation, by contrast, is something the technocratic Fed could deliver without the support of a divided Congress.

(2)  The Boomers’ secret lust for inflation

Why such eagerness for inflation?

  • Inflation hurts creditors.  Such as people living on the interest from their bonds, and retirees living on fixed pensions. But most Americans are debtors, most of whom have fixed rate loans (such as mortgages).  They benefit from inflation, as it erodes the weight of their debt.
  • The rich tend to have investments in assets whose values increase with inflation (such as land and business equity).  They benefit from inflation.
  • Some Americans have little debt and few assets.  Most of them are poor, and collectively have near-zero power in our economic and political systems.

Most Boomers would benefit from inflation, at least in terms of their balance sheets.  But even more important: the Boomers know how to manage inflation.

The great inflation of the 1970′s was the Boomer’s formative economic event, the backdrop to their early adulthood — imprinting them, like new born ducks on their mother.  Most missed that opportunity to get rich, either having no assets or ignorant of the game.  A new inflation would be the Boomers’ last opportunity to get rich.  For example by buying real assets (e.g., homes, gold, art) with fixed rate loans.

They can taste the opportunity.   Read conservative and investment websites and you can feel the excitement.  They’re lusting for it.

(3)  About inflation

Unexpected inflation provides the magic sauce for profligate governments, diminishing the burden of their debts.  But expected inflation makes things worse, not better.  When people see inflation, they take protective action.

  • Shorten the maturity of their loans (inflation has less effect on short loans)
  • Shift investment preferences from government bonds to inflation-protected bonds (e.g., TIPS) and hard assets.
  • Move money into harder currencies, or even physically move funds out of the country.

Consider our situation a year after inflation become visible. Everybody (including elderly widows in Smallville) will own nothing but hard assets, inflation protected securities, and short-term debt.  The average maturity of the Federal debt will be 2 weeks. {Correct: Tony notes in the comments that this is a silly exaggeration. Which it is. But the underlying point is correct.}

Under those circumstances the government would have to avoid inflation at any cost, as the resulting increase in its interest cost would be lethal.

(4)  For More Information

(a)  Posts about Inflation:

  1. Inflation is coming! Inflation is coming!, 7 February 2011
  2. Inciting fear of inflation in our minds for political gain (we are easily led), 28 February 2011
  3. Update on the inflation hysteria, the invisible monster about to devour us!. 15 April 2011
  4. The lost history of money, an antidote to the myths, 1 December 2012
  5. Lessons from the failed forecasts of inflation since the crash, 5 October 2013

(b)  Posts about monetary stimulus:

  1. The lost history of money, an antidote to the myths, 1 December 2012
  2. A solution to our financial crisis, 25 September 2008 — Among other things, large monetary action
  3. The lost history of money, an antidote to the myths, 1 December 2012
  4. Government economic stimulus is powerful medicine. Just as heroin was once used as a powerful medicine., 19 September 2013

(c)  Posts about our great monetary experiment:

  1. Important things to know about QE2 (forewarned is forearmed), 21 October 2010
  2. Bernanke leads us down the hole to wonderland! (more about QE2), 5 November 2010
  3. The World of Wonders: Monetary Magic applied to cure America’s economic ills, 20 February 2013
  4. The World of Wonders: Everybody Goes Nuts Together, 21 February 2013
  5. The greatest monetary experiment, ever, 20 June 2013
  6. Different answers to your questions about the momentous Fed decision to delay tapering, 20 September 2013
  7. Do you look at our economy and see a world of wonders? If not, look here for a clearer picture…, 21 September 2013
  8. Two warnings about quantitative easing, the taper, and what comes next, 27 September 2013
  9. A Fed Governor speaks honestly to us about the costs and risks of our monetary policy, 18 January 2014
  10. Wagering America on an untested monetary theory, 22 January 2014

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18 thoughts on “The Economist recommends taking the easy path to inflation. But what if it’s closed?

  1. Yet another superb post by FM. I take it that he remains quite skeptical of the prospects for Abenomics or continued expanded QE, as well he should, given the well-known economist’s adage about “pushing on a string.” (Link to an economics white paper proving that, indeed, monetary policy in the aftermath of a major recession far underperforms its usual efficacy. Why? Because after a major recession, as FM reminds us, “Things are different.”)

    The question then becomes why are so many Americanos remain so enthusiastic about such a dubious experiment… FM’s subtext here once again suggests that Americanos remain lost in a fog of self-delusion, seeking easy magical solutions like expanded QE instead of the much harder but more sensible solutions of beating back the influence of the superrich, taking back control of congress, and passing massive infrastructure stimulus programs would boost aggregate demand.

    FM doesn’t go into a great deal of detail about it, but his comment that ‘the world has changed’ is also spot-on. A lot of economists today continue to make confident predictions (see nonsense like A HREF=””http://money.cnn.com/2013/06/24/news/economy/econo”>alleged coming surge in the U.S. economy, apparently not realizing that in the aftermath of epochal once-in-3-generations economic bubbles, the economy typically takes decades to recover.

    See the paper “From free-fall to stagnation: Five years after the start of the Great Recession, extraordinary policy measures are still needed, but are not forthcoming” by the Economic Policy Institute, which does a good job of laying the reasons why we cannot expect anything remotely like a typical V-shaped recovery in the aftermath of this particular Great Recession.

    A great deal of evidence now shows that businesses are using the retirement of the baby boomers (confidentaly and foolishly predicted to augur vast new job openings for younger workers) and the deployment of new computer and robotics technologies to replace workers with machines, or eliminate the jobs entirely. These are the same economists of whom Paul Krugman wrote back on 2 September 2009 “How did economists get it so wrong?” Yet of course we’re supposed to believe their predictions today, in 2014, despite their five-year-plus record of failed and faulty busted predictions, not to mention their complete lack of ability to predict the popping of the housing bubble, or even recognize that the American economy was in one.

    Every year since 2009, economists have trumpeted an illusory takeoff in the American economy. Every year, the predicted economic boom has failed to materialize. The world has indeed changed. Today’s workers and investors, having lost their life savings in a Ponzi scheme of Brobdignagian size, will remain ill inclined to invest in houses or stocks for the restof their lives. This generation will cherish skinflint cheapness and thrifty living the same way the generation that lived through the Great Depression did, and as a result the prospects for any huge uptick in aggregate demand in the foreseeable future (for at least 10 years, and probably 20) remain nil.

    The world has indeed changed. Yet hardly anyone seems to realize it. Thanks once again to FM for cutting through the B.S.

    1. Thomas,

      Re: Abenomics

      I don’t know if it will work. I don’t see how it CAN work. They need to reverse the decline in nominal real wages — quickly. They need to fire the Third Arrow — structural reform — quickly. They need more tax money to pour in before interest rates rise (sending the government’s interest rate bill skyrocketing). The clock is running.

      But economists say I’m wrong. Time will tell.

  2. I second Thomas’ comment, FM. This is a superb post.

    I was reading today that Mark Zandi says the economy will grow; Roubini thinks otherwise. I haven’t heard yet from Shiller, Krugman, or Stiglitz on what they think.

    Zandi is not on my list of trusted economists, he gets paid to be optimistic and doesn’t suffer consequences for being wrong, Roubini is towards the bottom of my trusted list, a bit too gloomy, based on observation. The other three tend to be very solid (at least when they aren’t being political or emotional).

    1. Pluto,

      I have contacts with a few world-class economists. I spent an hour plus with one such on Monday discussing 2014 US GDP. He expects 3.0+ (with a bias to more than that) — an acceleration from the 2.2% of the past 4 years, and more so from 1.9% of 2913.

      He shares the consensus view, a consensus which is both wide and deeply held (I.e., as the IPCC would say, with high confidence.

      I will post my view this weekend. I am not an economist, but I do not see such great news coming.

    2. Pluto mentions: “I was reading today that Mark Zandi says the economy will grow; Roubini thinks otherwise. I haven’t heard yet from Shiller, Krugman, or Stiglitz on what they think.

      Krugman has mentioned in interviews that he is very much afraid that the U.S. economy in 2014 is following the trajectory of the Japanese economy circa 2000. In the November 2011 Munk debate, Krugman faced off against Larry Summers:

      The motion was that “North America faces a Japan-style era of high unemployment and slow growth”; Paul Krugman was arguing for it, while Larry Summers was arguing against.

      Source: “Krugman vs Summers: The debate,” Felix Salmon, 15 November 2011.

      But since 2011, Larry Summers appears to have changed his mind, raising concerns about what he calls “secular stagnation,” which basically boils down to Krugman’s worry that America today is where Japan was in the 1990s.

      You might imagine that speculations along these lines are the province of a radical fringe. And they are indeed radical; but fringe, not so much. A number of economists have been flirting with such thoughts for a while. And now they’ve moved into the mainstream. In fact, the case for “secular stagnation” — a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between — was made forcefully recently at the most ultrarespectable of venues, the I.M.F.’s big annual research conference. And the person making that case was none other than Larry Summers. Yes, that Larry Summers.

      And if Mr. Summers is right, everything respectable people have been saying about economic policy is wrong, and will keep being wrong for a long time.

      Source: “A Permanent Slump?” Paul Krugman, The New York Times, 17 November 2013.

      Robert Stiglitz wrote in his January 2012 Vanity Fair article “Book of Jobs” that:

      The banks got their bailout. Some of the money went to bonuses. Little of it went to lending. And the economy didn’t really recover—output is barely greater than it was before the crisis, and the job situation is bleak. The diagnosis of our condition and the prescription that followed from it were incorrect. First, it was wrong to think that the bankers would mend their ways—that they would start to lend, if only they were treated nicely enough. We were told, in effect: “Don’t put conditions on the banks to require them to restructure the mortgages or to behave more honestly in their foreclosures. Don’t force them to use the money to lend. Such conditions will upset our delicate markets.” In the end, bank managers looked out for themselves and did what they are accustomed to doing.

      Even when we fully repair the banking system, we’ll still be in deep trouble—because we were already in deep trouble. That seeming golden age of 2007 was far from a paradise. Yes, America had many things about which it could be proud. Companies in the information-technology field were at the leading edge of a revolution. But incomes for most working Americans still hadn’t returned to their levels prior to the previous recession. The American standard of living was sustained only by rising debt—debt so large that the U.S. savings rate had dropped to near zero. And “zero” doesn’t really tell the story. Because the rich have always been able to save a significant percentage of their income, putting them in the positive column, an average rate of close to zero means that everyone else must be in negative numbers. (Here’s the reality: in the years leading up to the recession, according to research done by my Columbia University colleague Bruce Greenwald, the bottom 80 percent of the American population had been spending around 110 percent of its income.) What made this level of indebtedness possible was the housing bubble, which Alan Greenspan and then Ben Bernanke, chairmen of the Federal Reserve Board, helped to engineer through low interest rates and nonregulation—not even using the regulatory tools they had. As we now know, this enabled banks to lend and households to borrow on the basis of assets whose value was determined in part by mass delusion.

      The fact is the economy in the years before the current crisis was fundamentally weak, with the bubble, and the unsustainable consumption to which it gave rise, acting as life support. Without these, unemployment would have been high. It was absurd to think that fixing the banking system could by itself restore the economy to health. Bringing the economy back to “where it was” does nothing to address the underlying problems.

      The trauma we’re experiencing right now resembles the trauma we experienced 80 years ago, during the Great Depression, and it has been brought on by an analogous set of circumstances. Then, as now, we faced a breakdown of the banking system. But then, as now, the breakdown of the banking system was in part a consequence of deeper problems. Even if we correctly respond to the trauma—the failures of the financial sector—it will take a decade or more to achieve full recovery. Under the best of conditions, we will endure a Long Slump. If we respond incorrectly, as we have been, the Long Slump will last even longer, and the parallel with the Depression will take on a tragic new dimension.

      Robert Shiller hasn’t said much about growth prospects for the U.S. economy going forward in the near term, except that “housing prices seem bubbly,” which sounds ominous.

      So out of the 4 savants you mentioned (Krugman, Shiller, Summers, Stiglitz), three of them appear to concur that “under the best of conditions, we will endure a Long Slump” (Stiglitz).

      Under normal conditions, I would certainly agree with FM that we would be well advised to follow the consensus of economists. Under typical economic conditions with a normal business cycle, the consensus of economists is probably likely to be in the ballpark of what we can expect in the near future, economically speaking. Trouble is, these are not normal economic conditions. America is now issuing government T-bills with a negative real interest rate — and people are snapping them up in record numbers. This is something I was told could never happen. The Federal Reserve has injected fantastic amounts of liquidity in the U.S. economic system, yet inflation hasn’t budged. According to Milton Friedman and the monetarists at the Chicago School of Economics, this is flatly impossible — yet it is happening. The Federal Reserve projections for economic growth over the last 5 years have been dropping like a rock, from 4.5% in 2009 to below 2% in 2013…yet the actual growth of the U.S. economy has consistently underperformed these constantly dropping growth projections.

      This chart is simply devastating, in my view. Once again, this is not supposed to happen in the aftermath of a recession.

      Clearly, we appear to be in atypical economic conditions. Under these circumstances, it seems to me that the majority of economists are following economic models and economic rules of thumb which apply well in the aftermath of normal Fed-caused recessions. But those economic models and economic rules of thumb (such as “lowering interest rates tends to produce economic growth,” “the fiscal multiplier is small and limited in effectiveness as economic growth accelerates,” “increasing liquidity tends to increase inflation,” and “investors will simply not purchase government-backed bonds with negative real rates of return”) just don’t apply in the extraordinary conditions after a major bubble and a balance sheet recession.

      Lowering interest rates does not produce economic growth today because the velocity of circulation has dropped to nil, since everyone is using every dime they get to pay down their debt, rather than make purchases of goods and services that would kick-start the economy.

      The fiscal multiplier near the zero interest lower bound, where we reside now, can be much larger than expected. (See the Federal Reserve Bank of San Francisco research paper Measuring the Effect of the Zero Lower Bound On Medium- and Longer-Term Interest Rates,” February 2012.)

      Increasing liquidity has not led to increasing inflation because individuals and businesses alike today are much more concerned about deleveraging their overwhelming debt than about improving their quality of life with purchases of goods or services.

      And people from all over the world are flocking to purchase U.S. government T-bills with negative real rates of return because the American financial system is so riddled with fraud and corruption that investors correctly believe that it is better to lose a small amount of money by parking their assets with the U.S. government (in an inflation-adjusted TIPS bill that pays -0.1% real rate of return) than to park their assets with some Ponzi scheme run by a group of sharks like Goldman and Sachs, and lose 100% of their assets due to endemic fraud.

      Under these circumstances, I think we should very cautious about agreeing with a majority of economists who have been consistently wrong since the collapse of the bubble in 2009. I agree with FM and with Paul Krugman and Larry Summers and Bob Stiglitz, and disagree with the economic consensus that calls for a rosy scenario with 3-4% U.S. GDP growth for 2014 and claims that inflation will heat up in the coming year. Like FM, I do not understand how QE can possibly revive the U.S. economy by itself.

      Time will tell…

    3. Thomas,

      You are confusing economist’s full-cycle forecasts with highly specific same-year forecasts. They are calculated somewhat differently.

      I don’t have the data handy, but the consensus range for real US GDP growth in 2014 is roughly 2.5% to 3.5% — an acceleration from the 2.2% average of the past few years and esp from the 1.9% of 2013.
      http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

      The November estimate for 2013 from the Fed’s Survey of Professional Forecasters was 2.6%.

      http://www.phil.frb.org/research-and-data/real-time-center/survey-of-professional-forecasters/2013/spfq413.pdf?CFID=10364482&CFTOKEN=16925477&jsessionid=84303eedc97b4798f1c6104b36496670124c

      The Fed’s estimate of long-term real GDP growth is 2.2% – 2.4% , from the briefing at the December Open Market Committee meeting (on the low end of consensus, I suspect). Quite slow vs our past (demographics will depress it for another generation).

      http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20131218.pdf

  3. A note regarding the praise from Thomas and Pluto –

    This post follows the pattern I have seen since starting writing in 2003: the posts that seem the strongest, the most valuable, the most powerful — tend to get low traffic. This one follows that “rule”.

    Sidenote:

    This post from October 2012 is just now getting some attention (I don’t know why): “Still good news: global temperatures remain stable, at least for now.”
    http://fabiusmaximus.com/2012/10/14/climate-global-warming-44028/

    It lists the peer-revised papers and reports from major climate agencies discussing the pause — a definitive to the climate activists who state that scientists believe there is no pause. I have quoted examples of this — an important development in the climate debates, where the left continues their decisive break with climate scientists (and the IPCC), moving to outright lies.

    By doing so they powerfully demonstrate the parallelism in American politics of which I have so long spoken, where both extreme mirror each other’s behavior. This should not surprise us, since they are both Americans.

    1. FM wrote:
      “This post follows the pattern I have seen since starting writing in 2003: the posts that seem the strongest, the most valuable, the most powerful — tend to get low traffic. This one follows that “rule”.”

      If it makes you feel any better, I’ve read (and enjoyed) almost every post of yours since I found this website back in 2008.

  4. The mainstream of the economics profession, which includes Summers, failed to either predict the time and extend of the Great Recession, or to pull the American economy out of a prolonged slump (which varies in its effects on different groups of people). Why should one give their diagnoses and prescriptions much credence now?
    One response, of course, is that they have learned from their mistakes. I doubt it. Modern economics seems to be severely limited in its epistemological validity. The axioms and models seem to be chosen because they findable: kind of like the man looking for his keys under the street light, because its easier to see there.

    Another response is that their policy prescriptions were not really put into effect, because of politics.
    Well, I’m sorry: politics is part of the world we live in, just like gravity. Politics is always part of the problem and solution.
    Furthermore, that’s an easy out. The fact his, Summers and his colleagues and students and fellow travelers were and are in power. They had their chance.
    My own feeling is that the Democrats are on the verge of major losses. They’ve owned the economy for some time. Advocates of deficit spending own the economy: everyone knows about the huge growth in the national debt over the past 5 years.

    I am not an economist, but I have a general sense that both the establishment and the nation as a whole is adrift, with no idea of what to do, or any sense of real hope or optimism. Just as the left has discredited itself on the climate change front, mainstream economics has discredited itself, whether this result is fair or not…
    On the ground, the 20-somethings are absolutely devastated. We’ve personally housed a few of them in our basement while they look for work. In all cases, they found entry-level, minimum wage jobs. Not a very good sign.

    1. Pub liusmaximus,

      (1). “Failed to pull the American economy out of a prolonged slump”

      False. The 2008-2009 crash was in most respects similar I’m magnitude to that of 1929-1930. Instead of a Great Depression, we had a severe recession. The economy has frown since the trough in Q1 2009. Since 2010 at an average rate of 2.2%.

      Perhaps that does not meet your standards of performance for economics. When you die you will go to a place where everything runs perfectly.

      (2). “Well, I’m sorry: politics is part of the world we live in, just like gravity. Politics is always part of the problem and solution.”

      You hold economists responsible for the actions of politicians whom you and I elect? When you are at the Pearly Gates, pray that you are not judged by such crazy high standards. Until then, look in the mirror to see one of the people responsible.

      (3). ” The fact his, Summers and his colleagues and students and fellow travelers were and are in power.”

      Take some economists to lunch and tell this to them. Everybody like a funny joke. Do not tell them you are serious. They’ll check the nearest exit, and slowly rise and leave. Don’t arouse the crazy guy….

      (4). “Advocates of deficit spending own the economy: everyone knows about the huge growth in the national debt over the past 5 years.”

      Yes, and everybody paying attention knows that the horrific results predicted by conservatives failed to happen, but that the recovery mainstream economists predicted did happen. What’s your point?

      (5). “mainstream economics has discredited itself, whether this result is fair or not”

      Please cite some evidence for your assertion. Failure to meet your high standards is not detminitative for all Americans. And most are Americans are, IMO, better informed about actual capabilities or economic theory and economists — knowing they’re not magic and magicians.

  5. A key statement in your conclusion seems…..questionable, at best, “…..Everybody (including elderly widows in Smallville) will own nothing but hard assets, inflation protected securities, and short-term debt….”

    I have have often appreciated the analysis on your site…absolutes (“Everybody”) tend to cause me to question the motives/strength of the commentator.

    There are many, many people who will not lever up to acquire hard assets, far more than not, in my veiw, and from my conversations. They understand, all to well, what happens when the music stops. And, they do not trust. Curious question is the move into financial instruments if yields move significantly…probably likely….and potentially a terrible trap The day of reckoning will come at the moment of our final exhaustion while trying to out run it.

    The system is now so complex, so imbalanced and flawed,and so disproportionately controlled by existing money’d interests (politics, banking), the possibility of broadly beneficial change is laughable, only a very painful catharsis will create an awakening of the masses, and consequently big change…we know how that turned out in China, and Russia for example. Understanding whats best is not possible. Understanding that turns some of us into true machiavelians. buy the sturdiest pair of running shoes available.

    1. Tony,

      You are absolutely correct. Good catch, and I will add a note to the post (with due credit ypto you).

      This was, of course, over-the-top rhetoric. Fun to write, but silly.

      As you note, only a minority fraction of assets will shift hands in the face of even the most obvious and horrific event.

      On the other hand, only a minority need shift hands to greatly affect prices. Which was the point I was making (badly): that Central Bank actions to induce substantial inflation (meaning depending on the conditions and context) risk sparking a rate rise that not only eliminates any beneficial effect of the inflation — on, for example, the government’s debt (historically one of the most common reason for inflation) — but can easily produce net ill effects from the resulting turmoil.

      Unexpected inflation is the magic sauce. However desirable, under current conditions that might be almost impossible to achieve in the US and Japan.

    2. Tony,

      “The system is now so complex, so imbalanced and flawed,and so disproportionately controlled by existing money’d interests (politics, banking), the possibility of broadly beneficial change is laughable, only a very painful catharsis will create an awakening of the masses, and consequently big change”

      I would very much like to prove you wrong. I would be happy just to believe that you are wrong.

      But a cold analysis suggests, IMO, that there are reasonably high odds that you are correct.

      On the other hand, organizing — including the necessary thinking about causes and solutions — can only help in all scenarios. Fortune favors the well-prepared.

  6. Unless we think in terms of dynamic systems in which all living systems operate, so does the economy, and include stock/flow and feedback loops there will be no exit from permanent risk of another downturn. Maybe by accident.

    While FED is doing all it can to produce expectations of higher inflation, it is not doing it in a way that does that, by raising interest rates. Market is watching interest rates as show of future inflation, it is not watching new monetary experiments that were never before present and never experienced as producing inflation, so market keeps watching at interest rates as a sign on inflation. It is what is used to do, it is how it is trained to do, it is how computer programs are programed. Market was never trained to look at QE as an inflation sign, but as sign of troubles ahead.

    In present situation of 0 interest rate, raising the interest rate could mean higher income to economy and more spending instead of reduction of credit creation which is suffering allready.
    But the fear of state indebtnes can prevent you and economists from thinking in this way.
    Paul Krugman is noting that ZLB could mean reversal of effects and that economy behaves contradictory to normal times. Effects like those of interest rates.

    That also means that risk of inflation is a positive and not a negative thing today. Or FED could just raise interest rates instead of waiting for expectations of inflations to be caused by other means that repeatedly did not work. There should be no fear of state solvency which prevents such thinking. Unless going to 10% interest rates. Interessting times we live in.

  7. So what are the real causes of inflation if money supply isn’t, which recent experience point to that money supply is not the cause of inflation? Isn’t that a nice experiment where most of the usual variables are reduced to constant and teological believes are exposed? Such belief as; money supply causes inflation.

    Wages control inflation. That is what post-keynesians, that more and more economists accept every day, teach. Sometimes there is price of energy that can push inflation even higher, or destruction of production, or prices that government offer in order to atract more products to itself.
    But, wages are the primer mover of inflation while other things are only giving support to allready present inflation.

    Thinking in those terms, it is questionable how to produce inflation or expectations of inflation when most wages are stagnating, even falling.
    Should we abandon thinking about money supply as the cause of inflation?

    Even the credit growth of past 30 years did not have raising inflation acompany it, but what acctually was showing was the falling inflation acompanying credit growth. Credit growth with wages together was not able to raise inflation = secular stagnation.

    In terms of feedback loop, wages (income) should be in the center and feedback loops with, inflation, interest rates, public deficit, profits, housing share.
    While inside the center, credit growth circles around wages forming a total income.
    It looks like an atom, doesn’t it, like a living system, but not in a 2D or 3D but like 4D with time included.

    1. Jordan,

      There is nothing surprising about the increase in the money supply not causing inflation. Mainstream economists predicted it (obviously including those at the Fed, since that forecast was the basis for their policy).

      The Wikipedia pages on monetary policy explain all this quite nicely.

      The question concerns the effects of unwinding the effects of ZIRP and QE. That is the unknown aspect of the experiment, with few historical precedents to guide the Fed’s staff and governors.

      Some questions:

      1. Has the economy adapted into unseen ways to extreme monetary policy, so that unwinding will be destabilizing?
      2. How quickly will the the money multiplier and monetary velocity recover?
      3. What effects will the normalization of monetary policy have on the economy?
    2. I can try answering;
      i. Economy feels no effects from QE, only banks do. Banks are squezed by need for cash and forced to give up most of their somewhat good assets for quick liquidity while the worst assets are still on their sheet. FED does not accept the worst of the assets for QE. That is what i read a while ago, a study on reduction of banks’ nonperforming assets by QE. QE is acctually removing asset income from banks. QE is not helping banks.
      The rise in stock market is due to transfering savings from real investment into stocks, not from QE, and there is the correlation with gold price and stock prices, gold is out while stocks are in.

      ii. Money multiplyer is in a slow fall as there is more and more unemployed and some of production capacity is getting destroyed as time pass by. There is no need for higher production capacity so the money is saved instead of invested. ( i know that there are more employed ones, but there are also more uneployed ones too) It will return as employment recovers. Imports also reduce money multiplyer. And the companies can easily raise capacity by making workers do more hours instead of employing new people.
      Velocity is in another problem, it will return when inflation returns. With inflation the real interest rate will rise and people will try to invest money or spend. To try to rise velocity i would recomend stopping QE and rise interest rates even tough they are well above Taylor rule. But higher interest rates by FED will put more income into the economy, income from interest rates. There should be no fears about public solvency that prevents such action.

      In order to quickly return the velocity, high marginal taxes are needed and then spent into the economy by infrastructure projects and direct employment (but not in NSA or defense for other reasons) which would employ money that otherwise go to savings or into nonproductive assets.

      iii. What is normal? Getting back to following Taylor rule and Philips curve? It can not return to it unless it gives negative rates, charging for reserves instead of paying for reserves at the FED.

      Monetary policy only works on expectations and only by change, not by having a rate stedy. Feedback loops and stock/flow are forced to adjust to a new condition, to new equilibrium.

    3. Jordan,

      You give these confident answers to questions debated by the world’s greatest economists. It doesn’t encourage confidence in your comments. This is not a good use of your time.

      I suggest that you instead cite experts on these questions. That would be use to people, and might stimulate discussions. Long long comments by people with no claim to expertise are, in my experience, ignored by readers. Especially when they display wild over-confidence.

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