Tag: Federal Reserve

Does High Unemployment Make Inflation Impossible?

Benn Steil and Paul Swartz wrote a technically brilliant yet readable Wall Street Journal tutorial explaining why “the Fed’s exit strategy is not credible, and that means a serious risk of high inflation down the road.” 

They are sure to be ignored by those of the Keynesian faith who have repeatedly assured us that inflation cannot possibly be a problem for many, many years.  Why not?  Because there is so much “slack” in the economy—a euphemism for high unemployment.
If this “slack theory” of inflation makes you too sanguine about future inflation, recall that it is the same theory that predicted stagflation would be impossible in 1973–75 and 1979–81.

Figures from The Economist, August 21, raise some doubts.  The latest unemployment rate in Argentina is 8.3%, but CPI inflation over the past year was 12.2%. Unemployment in Venezuela is 8.2%, but inflation is 13.3%. Unemployment in Egypt is 9.1%, but inflation is 10.7%.  Unemployment in India is 10.7%, but inflation is 13.7%.  Unemployment in Turkey is 11%, but inflation is 7.6%.   Wasn’t high unemployment supposed to make high inflation impossible

Perhaps Slack Theorists might take comfort from the fact that inflation is “only” 4.2% in South Africa, where unemployment is 25.3%.  But that is not exactly solid proof.

Whenever Keynesian dogma proves so completely at odds with the facts, there is a powerful inclination among true believers and their herd of media apostles to cling to the theory and diregard the facts. 

Some volatile economists who previously worried about near-term U.S. inflation have switched to assuming (as they did in 2003) that high unemployment will produce deflation.  Yet that is obviously not happening in the countries listed above.  The only country with falling prices is Japan, with an unemployment rate of 5.3% (and foolishly high tax rates and decades of wasteful ”fiscal stimulus”).

File the Steil-Swartz article away for future reference. 

And remember Reynolds’ Second Law: “Inflation is always lower before it moves higher.”

State Debt Doubles

CNNMoney.com reports on how state governments are digging themselves deep into debt. The story points to Moody’s Investor Service data on “tax-supported” debt, which is bond debt that state taxpayers will ultimately have to pay back.

The article shows the large variations in government debt across the states, and notes that “not every state is ratcheting up its borrowing. Many states have strict laws governing their debt issuance. Some places, such as Nebraska and Wyoming, have virtually no debt.”

I’ve argued that all state governments ought to follow the no-debt approach to state finance. With good planning, capital expenditures can be financed “pay-as-you-go” or out of current revenues. Debt creates bad incentives for politicians and makes it harder for citizens to understand complex state budgets.

The CNNMoney.com story notes that state debt soared 10.3 percent in 2009 as the economy struggled. But I’ve noted that Federal Reserve data shows that debt has soared in good times and bad over the last decade. The Moody’s data tells the same story, as shown below.

State debt outstanding doubled from $230 billion to $460 billion in just nine years, 2000 to 2009.

Even Keynesian Accounting Can’t Find All That ‘Stimulus’




Nobel Laureate Robert Lucas put it this way:


Show Me the Money

A number of economists have been warning about the Federal Reserve’s easy-money policy, but defenders of the central bank often ask, “if there’s an easy money policy, why isn’t that showing up in the form of higher prices?” Thomas Sowell has an answer to this question, explaining that people and businesses are sitting on cash because anti-business policies have dampened economic activity.

Not only has all the runaway spending and rapid escalation of the deficit to record levels failed to make any real headway in reducing unemployment, all this money pumped into the economy has also failed to produce inflation. The latter is a good thing in itself but its implications are sobering. How can you pour trillions of dollars into the economy and not even see the price level go up significantly? Economists have long known that it is not just the amount of money, but also the speed with which it circulates, that affects the price level. Last year the Wall Street Journal reported that the velocity of circulation of money in the American economy has plummeted to its lowest level in half a century. Money that people don’t spend does not cause inflation. It also does not stimulate the economy. …Banks have cut back on lending, despite all the billions of dollars that were dumped into them in the name of “stimulus.” Consumers have also cut back on spending. For the first time, more gold is being bought as an investment to be held as a hedge against a currently non-existent inflation than is being bought by the makers of jewelry. There may not be any inflation now, but eventually that money is going to start moving, and so will the price level.

I do my best to avoid monetary policy issues and certainly am not an expert on the subject, so I asked a few people for their thoughts and was told that perhaps the strongest evidence for Sowell’s hypothesis comes from the Federal Reserve’s data on “Aggregate Reserves of Depository Institutions” - specifically the figures on excess reserves. This is the money that banks keep at the Federal Reserve voluntarily because they don’t have any better options. As you can see from the chart, excess reserves shot up during the financial crisis. But what’s important is that they did not come back down afterwards. Some people refer to this as “money on the sidelines” and Sowell clearly is worried that it will have an impact on the price level if banks start circulating it. That doesn’t sound like good news. On the other hand, it’s not exactly good news that banks are holding money at the Fed because there are not enough profitable opportunities.

What this really tells us is that the combination of easy money and big government isn’t working any better today than it did in the 1970s.

Public Wants Fed Audit





Not Too Late to “Audit the Fed”

Last week I wrote about Senator Sanders’ “compromise” with Senator Dodd and the White House on auditing the Federal Reserve.  To re-cap, the compromise would drop any auditing of monetary policy and simply focus on the Fed’s emergency lending facilities.  See my previous post for why I believe that compromise is a big win for the Fed and a loss for the American public.

The good news is that Senator Sanders’ compromise does not end the debate.  Senator Vitter has filed an amendment (#3760) that mirrors the original Sanders’ amendment, including an audit of monetary policy.  With any luck, other Senators will be able to decide for themselves whether the Sanders-Dodd compromise offers sufficient transparency of the Fed’s actions.

I also highly suggest reading Arnold Kling’s recent Cato briefing paper on the issue, “The Case for Auditing the Fed Is Obvious.”

Federal Reserve 1, Transparency 0

It is being reported that the Senate has reached a “compromise” on Bernie Sanders’ amendment to audit the Federal Reserve.  This amendment was a companion to Ron Paul’s House bill that would have subjected both the Federal Reserve’s lending facilities and monetary policy to a GAO audit.  The compromise?  Drop the monetary policy audit.  It is hard to match Ron Paul’s reaction:  “Bernie Sanders has sold out.”

Congressmen Paul is 100% right on this.  While it is important to get details on the Fed’s emergency lending facility, those decisions are behind us.  The public has a right to know who benefited from the Fed’s actions, but the reality is that such an audit would change little going forward.  The real action is monetary policy.

After having spent seven years as a staffer on the Senate Banking Committee, I can attest that most senators, congressman and their staff have little understanding of the mechanics of monetary policy.  Just listen to any random appearance of the Fed chairman before Congress and you will immediately know what I mean.  But then, congressman in general don’t understand the workings of most federal programs.  That is one of the purposes of the GAO: to help explain to Congress how programs work and evaluate how well those programs are working.  I can think of no area more in need of such understanding than monetary policy.

Of course, some worry that an audit would undermine the claimed independence of the Fed.  For instance, former Hartford insurance exec, now Obama Treasury official, Neal Wolin praised the compromise, claiming the original language would “threaten the central bank’s independence from Congress.”  Sadly, Mr. Wolin is confused about the nature of the Fed.  If there is a constitutional basis for the Fed, it is Article I, Section 8’s delegation to Congress of the ability “to coin money, regulate the value there of,”  which Congress has delegated to the Fed.  The supposed independence of the Fed is from the Executive branch, not Congress.  And one of the very reasons for an audit is for the public to have a window into the dealings of the Fed with the Executive branch, most importantly the Treasury.  What Mr. Wolin and others are trying to protect is the favored relationship between Treasury and the Fed.  A GAO audit would shift the balance of power over the Fed away from the Executive and back to Congress, who despite its many problems, is directly accountable to the American public.

The gutting of the Sanders’ amendment is a huge win for both Wall Street and the Treasury (is there any longer a difference between the two?), and a massive loss and missed opportunity for the American public, and its representatives in Congress, to regain some control over an agency (the Fed) that has acted as a piggybank for both Presidents Bush and Obama.