The Wait to Reflate
Paul Krugman tossed off a brief note yesterday bemoaning the Federal Reserve’s brand spanking new inflation target (actually, the Fed said it was a “goal” – which is something you want to hit but know you often can’t). He bemoaned the fact that “2% is Not Enough” in the title of his post – which initially made me wonder why Paul would be writing about milk – to indicate his displeasure with the fact that the Fed wasn’t targeting a high enough rate of inflation.
Let’s leave aside, for the moment, the misplaced fears of “inflationistas” who see inflation hiding under every rock and behind every tree and who view the mere mention of the upward targeting of inflation as blasphemy (I wrote about that debate here, earlier this week). Prof. Krugman thinks that they are to blame for what he sees as the Fed’s tentativeness.
The point is that Paul, and others such as Ken Rogoff, believe that sustainable inflation can be engineered now as a monetary proposition (I suppose they would concede that some fiscal expansion would be necessary too, but Paul’s criticism is directed at the Fed) and I believe they are thinking wishfully.
Here’s the bottom line: Not only would it be nearly impossible to generate sustainable high rates of inflation in the present global macroeconomic climate without truly massive government spending programs, but the Fed is far more worried about missing the “goal” to the low side than it is willing to indulge itself in fantasizing about exceeding it.
In order to have sustainable inflation, wages must track price growth – perhaps with a lag, but certainly within a reasonable amount of time. And it better be a short amount of time because the consumer is so overleveraged that there is no way for him to maintain unit consumption if prices rise. In the absence of wage growth, rising prices choke the economy.
Wage growth is effectively foiled – or, in certain instances, capped as a practical matter – by the enormous global excess of labor and productive capacity which we have been facing as the legacy of the “freeing” of post-socialist nations. As I will continue to say until I am blue in the face, you can’t rather suddenly add 3.5 billion people to the free market (half the world’s population) and not expect the 700 million people in the developed world to remain competitive at dramatically higher wages than those accepted by the new arrivals.
And that, together with the classic debt-deflationary impact of the persistent overhang, is the reason this slump is both non-cyclical and so stubborn.
As an intellectual matter, I’d like to be able to reflate the U.S. economy to end the slump. I’d also like a pony. Without a New Deal sized re-employment effort (and even that might still backfire) it will be a long wait for both. Note price deflators in the GDP numbers this morning.
15 Responses to “The Wait to Reflate”
Paul Krugman has repeatedly made both the argument that fiscal expansion is necessary to fight a recession and the argument that the Fed should try to set the target inflation rate higher although it doesn't have the power to set it as high as one might wish.
He has, as have I. The point above is that the Fed is powerless to engineer inflation on its own. Targeting inflation is only useful relative to expectations.The real thing is unsustainable without considerable fiscal spending aimed directly at re-employment. This would artificially support prices in the U.S. as it will increase aggregate demand (for as long as it lasts). The trick is making it last long enough to make headway on excessive global labor (i.e. increase global aggregate demand), or it too would fizzle.
I am sure you are right. In any case, the rich countries could and should be doing better. People like you and Paul Krugman certainly know how.
I am an engineer, not an economist. I wonder how it would feel if politicians instead of letting engineers solve engineering problems tried to revoke the laws of thermodynamics. Wait, that was Bush's hydrogen economy, a fuel that burns into water and then can be remade out of water. What next, biology without Darwin?
what I would really like is that the overall debate focus move into currencies floating regime.
Is it still acceptable that western word try to escape recession through QEs
while China appreciate its currency on a step-by-step basis ?
Wouldn't that approach leave unsolved a key structural issue to rebalance
world trade growth distribution ?
Why a country can enter free markets (i.e.: China as a WTO member) without accepting
(or being obliged) to let float its currency freerly (i.e.: as $ or €) ?
Furthermore, why not western world put that condition as a mandatory prerequisite
(i.e.: by changing WTO-IMF regulations) ?
Thanks in advance if you could reply my questions.
Seems to me the FED could easily choke off any undesired inflation should it become a problem for the economy by agressively raising rates. It's the ability to INCREASE inflation that's the problem now since the zero lower boundry prevents further interest rate reductions. Hence the QE(n)…
Yes, that's the point of the above. And price inflation (which can be fairly easily generated via QE and other means) w/o wage inflation is not effective.
Both WTO membership and U.S. most favored nation status generally require other countries to permit free trading and exchange of their currencies. However, under GATT, exceptions can be made for developing countries. In hindsight, it is clear that the negotiations leading to the admission of China were not farsighted enoungh back in 1994. The Chinse have been given a tremendous amount of leeway and forcing them to relinquish it without geopolitical destabilization is pretty much a non-starter. So weneed multilateral discussions to discuss moderating imbalances on all fronts.
now I have a better understanding about the root cause, at least in my opinion, of the mess that western world is facing since beginning of the so called Great Recession.
Now it is up to me to forward to you…….Grazie tante
Good luck getting any sort of fiscal policy that will actually have a positive impact on jobs. It simply won't happen with this Congress, as they're all thinking about November's elections.
Excess capacity in capital and labor markets, which you remark on, is "relative to demand" (as you mentioned in a recent interview. Demand is impervious to the Fed's actions, since it has to go through investment that is not happening. Inflation, likewise, is not happening in spite of the enormous rise in the monetary base (except insofar as it is affecting commodity prices through financial markets).
To say that inflation and demand are beyond the reach of fiscal policy is not right. It just depends on whether it is the taxing or spending side you use. For example, it is only too obvious that the $480 billion involved in the 2% payroll tax cut could be spent on 10 million jobs at $48,000 per and create both inflation and demand.
I noted above "Without a New Deal sized re-employment effort (and even that might still backfire) it will be a long wait [to reflate the US economy]" – I am an advocate of intensive fiscal action to straddle the period during which global demand will slowly catch up with excess supply. See the paper I wrote the Roubini and Hockett: http://newamerica.net/sites/newamerica.net/files/…
The parenthetical about backfiring referes to my concerns that (a) an intensive fiscal spending program that is not directly oreiented to job creation (such as you describe) could be worse than the disease (producing higher deficits with no jobs) – so it would need to be very targeted as we propose in "The Way Forward," and (b) the program would need to be of long enough duration to effect the straddle without fizzling our prematurely.
I hope that addesses your question.
I cede your point.. Though I have to observe that the excess supply problem is in tradable goods. The public goods that would be the likely product of employment programs may not disrupt the private sector, and so the jobs program could be permanent, on the order of that the MMT-ers advocate.
I was not aware of this "The Way Forward" paper. This is absolutely outstanding. One might say that it describes the ONLY path forward, and others — including all that are now being implemented — are either marching in step or going backward, and so ought to be viewed with alarm.
Of course, I would like to comment in detail. (Is there a place to do that?) The principal observation here is that the reason monetary reflation continues to be tried and austerity is the means of choice by policy-makers is the political influence of those who would be the short-term losers in your more comprehensive and logical program. I guess a second would be that education and sustainable energy development share a good deal with infrastructure as activities that return real value and improve demand. The excess capacity exists only in the tradable goods space.
But I am tempted to go on too long. I have not seen anything so coherent and comprehensive and on target as this.
It's amazing how few people pay attention to prices they pay and what they paid in the past.Also,many not aware of the rampant product downsizing going on.I don't have that great a memory,but I do know that we don't have a deflation problem.Just as govt vastly understates "real" unemployment,they do the same with inflation.You don't need a strong economy for prices to rise.I don't think Zimbabwe had too high employment and a great economy,causing hyperinflation.Great time to be holding gold and other real assets.They should do well.
Inflation isn't happening; but Banks are able to "carry trade" out of their overhang of trouble, and OIL is able to maintained at $100+ which funds more buccaneering in the middle east.
Wasn't there a book out some time ago titled something like "the Myth Makers"? Or was that a Dr Who episode? IN any case, the title is the thing as I see a huge number of budding myth makers out there trying to turn our harsh economic reality into myth.
Like for example – the idea that we have low inflation. As a former accountant, prices have always been something that I notice. A few years ago I noticed that the package of ten burritos for about $3 had suddenly become a package of 8 burritos for the same $3. Likewise the "fun packs" of little candy bars went from ten per pack to 8 for the same price. This product to price ratio was happening across the board in the grocery aisles, with the coffee companies going so far as to shrink the size of the can. Why? Because of inflation. The above is how a producer attempts to cushion their sales from price shocks that are the result of high inflation – in this case about 20 to 30%. Yet during this same period we saw BBB (Bungling Ben Bernanke) telling us that we were only having 1 – 2% inflation, and others trying to say there was NO inflation. Myth.
After reading your piece, I see that understating inflation is being carried to new extremes – by saying we are actually experiencing deflation. Sorry. That's not deflation you're seeing. It's the results of devaluation of the dollar caused by the mad printing presses at the FED – which causes a lack of purchasing power by the workers who still have jobs and who are being competitively readjusted into poverty.
I also see a lot of references to the Chicago Boys and their theories, and Keynesians, and such, but not much is said about the Austrian school… (except your claim to a 25% share.)
The real problem is rather more complex – but the principle aspects of it are – the underlying currency is fiat currency – and therefore worthless and subject to manipulation, the people are beginning to understand that fiat money isn't worth much because it is becoming more and more worthless every day, the privatization of banking profits and the conversion of banking losses to public debt which causes banks to disregard prudent and conservative business principles and behavior, the wasteful spending of debt-money by the government on "green energy" projects and other worthless bailouts of failing firms (such as GM), and the imposition of costly and worthless government regulations on business, while at the same time REFUSING to properly regulate the banking industry.
The underlying problem is that we are in what I call a "financial recession" – which is caused by the lack of or improper regulation of the banking/financial industry. The whole mega-mess was kicked off by the repeal of the last vestiges of Glass-Stegall by a mixed Congress and Bill Clinton. And until proper regulation of the banking industry is restored, there will BE NO RECOVERY!!!
(I believe that there are at least two kinds of recession – the above mentioned "financial recessions", and "business cycle recessions." which are caused by imbalances in supply and demand. While business cycle recessions are short term and self-correcting, financial recessions are neither.)
But that's just my opinion. Oh… and I'd be pleased to see a readjustment of terminology. We're in a depression, not a "Great Recession."