What Were They Thinking?

As the Fed sets in place the road map to withdrawing monetary stimulus, I wonder how it is that so many believed the Fed’s implementation of unconventional monetary policy would lead to surging high inflation. Examples include House Budget Committee Chair Paul Ryan, who stated in November 2008:

I think it’s going to give us a big inflation problem down the road.

The source for the above statement, Reuters, also quotes Sarah Palin and Ron Paul.

Time to look back. Here are some graphs depicting inflation and inflation expectations as they evolved.

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Figure 1: Annualized three month inflation for CPI (blue), personal consumption expenditure (red), core CPI (bold dark blue), and core PCE (bold dark red), in percent. Source: BLS, BEA via FRED, and author’s calculations. 

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Figure 2:Expected inflation calculated from difference between 10 year constant maturity Treasuries and TIPS (dark blue), from 5 year (purple), and mean expected 10 year CPI inflation from Survey of Professional Forecasters, in percent. Source: BLS, BEA via FRED, and SPF from Philadelphia Fed, and author’s calculations.

The obvious point is that there has been little evidence of inflation “getting out of control”, even as several bouts of quantitative easing were undertaken. In fact, inflation and inflation expectations have been remarkably quiescent. Why were these people so mistaken? There are at least two competing explanations, consistent with the statements that were made, and the observations we have:

  • The observers were ignorant of economics.
  • The observers wished to whip up hysteria in order to prevent the Fed from undertaking expansionary policies.

Both are plausible. The second possibility is more interesting to me (the first possibility is examinedhere). Why would these people wish interest rates to remain high? Perhaps they hoped that high interest rates would force a reduced level of government spending –- i.e., it would have “starved the beast”. In other words, instead of just cutting food stamps (SNAP) as the House is trying to do now (although not ag production subsidies [0]), even more swaths of the government could’ve been cut had monetary policy been less accommodative. Of course, the “starve the beast” hypothesis has had little empirical basis, as Jeff Frankel has pointed out (as well as Bruce Bartlett). But empirical evidence has not usually been marshalled on that side of the argument anyway.

A third argument, that Fed unconventional monetary policies were ineffective, and hence should not been undertaken, seems to run counter to recent empirical evidence indicating that the imminent cessation of QE has led to higher real interest rates (after all, if QE couldn’t push rates down, why should the mention of ending it pull rates up?). The increase in real rates since the Chairman’s June speech is depicted below in Figure 3:

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Figure 3: Ten year TIPS yields (dark blue), and five year TIPS yields (dark red), in percent. Source: FRED.

As Brad Delong observes, this is not good news, given that 2013Q2 GDP growth seems pretty poor.[1] Macroeconomic Advisers puts second quarter growth at 0.6% (SAAR).
A final graph depicts money base and gold prices, for those who believe gold prices are a summary statistic for all things under heaven.

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Figure 4: US money base, in millions of dollars (blue, left scale), and price of gold in London, 10:30AM, dollars per Troy ounce. Source: FRED.

Statements surrounding this graph I do think are more akin to the pure “tin-foil cap” sort (money base increase equals debasement; see this post).

This piece is cross-posted from Econbrowser with permission. 

4 Responses to "What Were They Thinking?"

  1. Bogwood   July 16, 2013 at 10:50 pm

    It is a measure of the morass that the charts and apparently logical arguments are unconvincing. No one knows the true costs of vital parts of the economy. Take natural gas. Reasonable people argue that the true cost of a unit of "tight" natural gas is 2-3 times the current 3.61$. The financial games causing the NG price problems would not be possible without the Fed and its QEase.
    Are house prices up 12% or not? Health care? Education? Even the Billion price index is above the government inflation figures. Then there is the 5-8% negative hedonic figure needed to adjust for environmental degradation and resource depletion. There is a problem but possibly not ordinary garden variety inflation.

  2. Tejas552   July 17, 2013 at 3:13 am

    The problem is that very few people who call themselves economists know what inflation really is. There is unfortunately a whole lot of people thinking that inflation is a sustained increase in a price index such as the CPI or PPI and/or a sustained increase in some overall price level. This is entirely misguided. Inflation refers to the purchasing power of money and nothing else. If the DowJones rises more than 100% between 2009 and now this erodes the purchasing power of money – this is inflation no matter what artifical constructs such as CPIs and PPIs measure.

  3. windriven   July 17, 2013 at 9:21 am

    I wouldn't crow just yet Mr. Chinn. We are still very early in this experiment and its consequences may not become apparent for some time yet. US GDP sucks – just a little less than other western economies. Job creation is sluggish and many new jobs are part time at relatively low wages. But M1 has grown at >10% year on year on average during the QE era. Absent some meaningful change in fundamentals it looks to me like a long period of stagflation on the horizon.

  4. margsview   July 30, 2013 at 8:36 pm

    And here I was wondering about currency wars?