Post by psychecc on Aug 18, 2008 14:26:11 GMT -6
Not sure I like the author's relationship to the Council on Foreign Relations, but this is a short, sweet condemnation of all the funny money. Link to the WJS article follows.
We'll All Pay For the Fed's Loose Money Follies
By BENN STEIL
August 18, 2008
In the dozen or so years until 2007, it had become as close to a global orthodoxy in economic policy making as we ever see: Central banks should target a low and stable rate of inflation....
The U.S. Federal Reserve, the European Central Bank, the Bank of England and other rich-country central banks have generally made 2% inflation, give or take a smidge, the touchstone of good performance. Fed officials have for 20 years paid public obeisance to their statutory "dual mandate," to maximize employment as well as stabilize prices. But in practice, until recently, they treated it much like a mildly embarrassing biblical injunction that could be safely ignored, if not repudiated.
Yet one of the great attractions of inflation targeting was that it only appeared to constrain central bankers' discretion. Other objectives which today's central bankers actually think are far more important -- in particular, keeping growth of that great aggregate of aggregates, "gross domestic product," above 0% -- can be safely pursued in place of price stability.
This is because the inflation target is what's called a "medium-term objective." The Fed is actually free to slash its key interest rate from 5.25% to 2%, stuffing the world with dollars, even as inflation soars past 5.6% (a 17-year high), because the public's inflation expectations will supposedly remain "well anchored." That is, we will eventually stop charging and paying each other ever higher prices for stuff, in spite of the flood of Fed money, because we know that once the Fed prints enough of it to fix our problems it will get really mad over the inflation we produced and target it with a vengeance.
Unless, of course, it hurts the GDP number, in which case the "medium term" will just be a bit longer. You get the picture.
The irony of the collapse of inflation targeting's intellectual edifice is that it has long been championed by Fed Chairman Ben Bernanke, not to mention departing Fed Governor Frederick Mishkin, who recently made a call for "establishing a transparent and credible commitment to a specific numerical [inflation] objective." This after siding with the doves on every rate vote, even as inflation soared to triple his preferred target.
The logic behind central bank discretion is that the economy is like a giant factory churning out 100 widgets a year, all of which are happily bought by consumers without prices rising. A sudden "exogenous shock" cuts demand to 98 widgets. But the central bank can then print money to induce consumers to buy up the two excess widgets, thereby stopping the factory from cutting production capacity and causing a "recession." It claws back the excess money when "equilibrium" is restored.
But what if this analogy is deeply flawed? What if the economy is much more like two factories than one? One factory produces, say, real-estate widgets, and the other produces everything else. If consumers decide they want fewer real-estate widgets and more of some other widgets, it will take time and resources for capacity to shift from the first factory to the second. "GDP" growth will decline during that time. But the process is normal and desirable. By printing more money, the central bank only makes it longer and more painful, not least by producing significant and prolonged inflation.
This is the serious mistake the Fed has made. And in so doing, it has probably killed the last great hope for a sound, durable global fiat money system -- inflation targeting.
Mr. Steil is director of international economics at the Council on Foreign Relations, and a co-author of "Money, Markets and Sovereignty" (Yale University Press, forthcoming).
online.wsj.com/article/SB121901927922648261.html
We'll All Pay For the Fed's Loose Money Follies
By BENN STEIL
August 18, 2008
In the dozen or so years until 2007, it had become as close to a global orthodoxy in economic policy making as we ever see: Central banks should target a low and stable rate of inflation....
The U.S. Federal Reserve, the European Central Bank, the Bank of England and other rich-country central banks have generally made 2% inflation, give or take a smidge, the touchstone of good performance. Fed officials have for 20 years paid public obeisance to their statutory "dual mandate," to maximize employment as well as stabilize prices. But in practice, until recently, they treated it much like a mildly embarrassing biblical injunction that could be safely ignored, if not repudiated.
Yet one of the great attractions of inflation targeting was that it only appeared to constrain central bankers' discretion. Other objectives which today's central bankers actually think are far more important -- in particular, keeping growth of that great aggregate of aggregates, "gross domestic product," above 0% -- can be safely pursued in place of price stability.
This is because the inflation target is what's called a "medium-term objective." The Fed is actually free to slash its key interest rate from 5.25% to 2%, stuffing the world with dollars, even as inflation soars past 5.6% (a 17-year high), because the public's inflation expectations will supposedly remain "well anchored." That is, we will eventually stop charging and paying each other ever higher prices for stuff, in spite of the flood of Fed money, because we know that once the Fed prints enough of it to fix our problems it will get really mad over the inflation we produced and target it with a vengeance.
Unless, of course, it hurts the GDP number, in which case the "medium term" will just be a bit longer. You get the picture.
The irony of the collapse of inflation targeting's intellectual edifice is that it has long been championed by Fed Chairman Ben Bernanke, not to mention departing Fed Governor Frederick Mishkin, who recently made a call for "establishing a transparent and credible commitment to a specific numerical [inflation] objective." This after siding with the doves on every rate vote, even as inflation soared to triple his preferred target.
The logic behind central bank discretion is that the economy is like a giant factory churning out 100 widgets a year, all of which are happily bought by consumers without prices rising. A sudden "exogenous shock" cuts demand to 98 widgets. But the central bank can then print money to induce consumers to buy up the two excess widgets, thereby stopping the factory from cutting production capacity and causing a "recession." It claws back the excess money when "equilibrium" is restored.
But what if this analogy is deeply flawed? What if the economy is much more like two factories than one? One factory produces, say, real-estate widgets, and the other produces everything else. If consumers decide they want fewer real-estate widgets and more of some other widgets, it will take time and resources for capacity to shift from the first factory to the second. "GDP" growth will decline during that time. But the process is normal and desirable. By printing more money, the central bank only makes it longer and more painful, not least by producing significant and prolonged inflation.
This is the serious mistake the Fed has made. And in so doing, it has probably killed the last great hope for a sound, durable global fiat money system -- inflation targeting.
Mr. Steil is director of international economics at the Council on Foreign Relations, and a co-author of "Money, Markets and Sovereignty" (Yale University Press, forthcoming).
online.wsj.com/article/SB121901927922648261.html