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How the Fed Can Fix the Economy
 

chabo11's picture
(Orangutan, 310
 
Points)
 on 4/26/12 at 6:59pm
inflation.jpg

The recent back-and-forth between Paul Krugman and Ben Bernanke illustrates that there is no definitive answer to this issue. Krugman argues that Bernanke is unwilling to try any policies that aren’t absolutely guaranteed to work. In other words, he’s shielding the Fed from criticism and political backlash.

The Fed is supposed to pump up the economy when it’s running too cold, with unemployment high and inflation low. That’s where we are right now, in the Fed’s own estimation. Yet the most recent minutes, from March, show Fed officials unwilling to take any further action to boost the economy.

Krugman’s answer to the problem? Raise inflation expectations.

I agree, to an extent.

Here are some key points supporting and criticizing the case for greater inflation, followed by my own analysis of its possible effects:

Benefits of greater inflation:

  • Krugman says: Inflation would lead people to spend faster to beat rising prices, thus boosting demand and reducing unemployment.
  • Corporations are sitting on a large hoard of cash. Inflation would act as a spur to investment by giving businesses and consumers less incentive to sit on their money.
  • Modest inflation could help reduce the real value of debt.

Downsides of greater inflation:

  • Bernanke says: Inflation could hurt the Fed’s credibility as a force for stable prices, which could give the Fed less flexibility in the future.
  • Inflation would decrease the purchasing power of the dollar and is especially hard on retired people, who rely on fixed income. This is important as Baby Boomers begin to retire.
  • See my comments below

My thoughts: I agree with some of these points and have issues with others. Specifically, I think the Fed could be taking more aggressive action. Bernanke’s policies have prevented a double dip recession, but they haven’t exactly jumpstarted the economy. I’m not saying I could have done a better job, but I am saying perhaps Bernanke 10 years ago could have. I also agree with Krugman that while raising inflation expectations risks damaging the Fed’s credibility, the risks of losing some credibility pale beside the risks of inaction.

However, I disagree that inflation will necessarily eat away at debt. Suppose, for example, that households do not see their nominal wages rise along with the general rise in prices. This could limit consumption and act as a tax on income. Moreover, people don’t always respond to greater inflation with greater spending. In many cases, households will cut back on expenditures in anticipation of expected higher prices.

Bernanke hasn’t done a terrible job at the Fed by any means, and he’s obviously in a difficult position right now. It’s also easy for Krugman to criticize when he will not have to directly answer for the extra risks involved with raising inflation and overseeing the economic well-being over 300 million people. Still, Krugman raises some good points.

If you were Ben Bernanke, what would your next move be? Keep inflation low, or raised expectations for future prices? Would you pursue QE3?

Should we be looking to fiscal policy rather than monetary policy to solve our current unemployment problem?

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    "The only thing that interferes with my learning is my education." Albert Einstein
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Comments

blackrainn's picture

We are really stuck

O
(Orangutan, 354
 
Points)
 on 4/26/12 at 7:22pm

We are really stuck here.

However, I think credibility is most important. We want to be the bastion of safety as people flee Europe / Japan. We don't want to be the next one in line.

I agree with Bernanke on this one. There is not much left for the FED to do.

Also, Paul Krugman's personality annoys the hell out of me, so there's that too. A first rate economist, but he has an ego and an axe to grind like no other.

solb22's picture

See my thread on Japan: An

 
Points)
 on 4/26/12 at 7:34pm

See my thread on Japan: An interesting proposal for a better QE than Krugman's proposal

http://www.wallstreetoasis.com/forums/a-refreshing...

Abdel's picture

(No subject)

O
(Neanderthal, 2,064
 
Points)
 on 4/26/12 at 7:35pm

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canyonman's picture

absolutely incredible. The

(Baboon, 112
 
Points)
 on 4/26/12 at 7:38pm

absolutely incredible. The keynesian mentality, fix the problem by creating a new one. Incredible. Absolutely incredible.

JeffSkilling's picture

I love this notion that

(King Kong, 1,911
 
Points)
 on 4/26/12 at 8:23pm

I love this notion that raising inflation fears is the solution, or even a positive. That's like suggesting to a struggling store owner that he should jack up all his prices 20% and announce that they're going up another 50% next week. Economics, unlike what many are lead to believe, is actually very simple. If a proposed solution sounds weird, it probably is.

OP you're asking what would be a better solution to our problems, monetary policy or fiscal policy? How about neither. How about we return to what made this country great; limited government, no taxes, sound money, stable rule of law. How easily we've forgotten all those things.

Bernanke is clueless (See pre-07 interviews), Krugman is dishonest beyond belief, why people even talk about them anymore I'll never understand.

whatwhatwhat's picture

god i fucking hate krugman

HF
(King Kong, 1,409
 
Points)
 on 4/26/12 at 9:10pm

god i fucking hate krugman

swagon's picture

whatwhatwhat: god i fucking

EN
(Neanderthal, 2,973
 
Points)
 on 4/26/12 at 9:38pm
whatwhatwhat:

god i fucking hate krugman

krugman hater, its called a krater. so now u know.

evilbyaccident's picture

chabo11: Krugman says:

 
Points)
 on 4/26/12 at 10:06pm
chabo11:
  • Krugman says: Inflation would lead people to spend faster to beat rising prices, thus boosting demand and reducing unemployment.
  • Corporations are sitting on a large hoard of cash. Inflation would act as a spur to investment by giving businesses and consumers less incentive to sit on their money.

    • This is the stupidest thing I've ever read.

    TNA's picture

    Krugman is a fucking moron.

    O
    (Human, 13,540
     
    Points)
     on 4/26/12 at 10:09pm

    Krugman is a fucking moron. The Fed can help the economy by allowing things to sort itself out.

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    canyonman's picture

    hey cmon guys hes gotta noble

    (Baboon, 112
     
    Points)
     on 4/26/12 at 10:25pm

    hey cmon guys hes gotta noble prize.

    JDawg's picture

    evilbyaccident: chabo11: Kr

    (Gorilla, 518
     
    Points)
     on 4/26/12 at 10:28pm
    evilbyaccident:
    chabo11:
  • Krugman says: Inflation would lead people to spend faster to beat rising prices, thus boosting demand and reducing unemployment.
  • Corporations are sitting on a large hoard of cash. Inflation would act as a spur to investment by giving businesses and consumers less incentive to sit on their money.

    • This is the stupidest thing I've ever read.

    Uh...do you actually have an argument to refute those points? This is basic econ 101.

    JDawg's picture

    JeffSkilling: I love this

    (Gorilla, 518
     
    Points)
     on 4/26/12 at 10:41pm
    JeffSkilling:

    I love this notion that raising inflation fears is the solution, or even a positive. That's like suggesting to a struggling store owner that he should jack up all his prices 20% and announce that they're going up another 50% next week.

    I don't think that's a good analogy. QE -> lower interest rates + raised inflation expectations -> increased borrowing -> increased spending (ie. increased demand) -> increased revenue for "struggling store owners" and increased prices due to the higher demand. Inflation doesn't mean that store prices are jacking up prices for the hell of it.

    JeffSkilling:

    How about we return to what made this country great; limited government, no taxes, sound money, stable rule of law.

    How the fuck can you have a government without taxes?

    WalMartShopper's picture

    Exactly...the best thing you

     
    Points)
     on 4/26/12 at 10:55pm

    Exactly...the best thing you can do is leave the economy the fuck alone...can't stand rent-seeking behavior.

    Abdel:

    If the glove don't fit, you must acquit!

    canyonman's picture

    JDawg: evilbyaccident: ch

    (Baboon, 112
     
    Points)
     on 4/26/12 at 10:46pm
    JDawg:
    evilbyaccident:
    chabo11:
  • Krugman says: Inflation would lead people to spend faster to beat rising prices, thus boosting demand and reducing unemployment.
  • Corporations are sitting on a large hoard of cash. Inflation would act as a spur to investment by giving businesses and consumers less incentive to sit on their money.

    • This is the stupidest thing I've ever read.

    Uh...do you actually have an argument to refute those points? This is basic econ 101.

    LOL. more like basic fallacy 101.

    evilbyaccident's picture

    JDawg: evilbyaccident: ch

     
    Points)
     on 4/26/12 at 10:59pm
    JDawg:
    evilbyaccident:
    chabo11:
  • Krugman says: Inflation would lead people to spend faster to beat rising prices, thus boosting demand and reducing unemployment.
  • Corporations are sitting on a large hoard of cash. Inflation would act as a spur to investment by giving businesses and consumers less incentive to sit on their money.

    • This is the stupidest thing I've ever read.

    Uh...do you actually have an argument to refute those points? This is basic econ 101.

    You want to reduce the purchasing power of Americans? You want them to spend MORE? Overspending is what got us into this problem in the first place. And how is this action going to boost demand? Demand is the desire to own anything, the ability to pay for it, and the willingness to pay. The desire to own anything has never been a problem, but inflation will reduce the ability to buy things.

    Yeah corporations are sitting on a large stockpile of cash, but fears of inflation aren't going to make them invest in dollar denominated assets, they'll simply move their money overseas.

    Are you stupid? It's an honest question, I was going to write more but I'm not sure that you'll be able to understand. If you're not stupid I'm sorry.

    chabo11's picture

    Corporations obviously have

    (Orangutan, 310
     
    Points)
     on 4/26/12 at 11:17pm

    See my WSO blog

      "The only thing that interferes with my learning is my education." Albert Einstein
    JDawg's picture

    evilbyaccident: You want them

    (Gorilla, 518
     
    Points)
     on 4/26/12 at 11:47pm
    TNA's picture

    Another great example of why

    O
    (Human, 13,540
     
    Points)
     on 4/26/12 at 11:51pm

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    JeffSkilling's picture

    JDawg I would encourage you

    (King Kong, 1,911
     
    Points)
     on 4/27/12 at 2:04am
    JeffSkilling's picture

    JDawg: JeffSkilling: I love

    (King Kong, 1,911
     
    Points)
     on 4/27/12 at 2:01am
    Abdel's picture

    ''Keynes must die, so the

    O
    (Neanderthal, 2,064
     
    Points)
     on 4/27/12 at 2:39am
    Cola Coca's picture

    The optimal savings rate is

    O
    (Orangutan, 321
     
    Points)
     on 4/27/12 at 4:11am
    JeffSkilling's picture

    Cola Coca: The optimal

    (King Kong, 1,911
     
    Points)
     on 4/27/12 at 4:21am
    AndyLouis's picture

    interesting, thanks for

     
    Points)
     on 4/27/12 at 8:14am

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    KingEastwood's picture

    What's even more annoying of

    IB
    (Monkey, 50
     
    Points)
     on 4/27/12 at 8:53am
    Abdel's picture

    (No subject)

    O
    (Neanderthal, 2,064
     
    Points)
     on 4/27/12 at 2:29pm
    JDawg's picture

    JeffSkilling: JDawg I would

    (Gorilla, 518
     
    Points)
     on 4/28/12 at 1:08am

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