Suppose the Fed Wanted to Create More Inflation…Could They?

February 3rd, 2013 at 12:50 pm

I’ve been meaning to comment on this interesting piece from yesterday’s NYT on how some would like to see the Federal Reserve do more than they’re already doing to stimulate growth.   Specifically, the argument goes, they should be trying harder to raise the rate of inflation, which has lately been below their 2% target.

Inflation, unlike job creation, is something the Fed can control with some precision. Higher inflation could accelerate economic growth and job creation by encouraging people to spend more and make riskier investments.

Yet annualized inflation fell to 1.3 percent in December, and asset prices reflect an expectation that the pace will remain well below 2 percent in the next decade.

Now, there are two major arguments against this line of thinking.  The first, most dominant one is that the Fed should always be hawkish on inflation, they’re already playing with fire, and they should, if anything, do less here not more.  It’s often an argument made by those with large quantities of assets whose value would be eroded by higher inflation, or by lenders as opposed to borrowers.   That’s certainly not my argument.

But the second argument is that even if they wanted to, in the current weak demand climate, even a lot more “quantitative easing”—the Fed’s bond purchase program—wouldn’t move the inflation needle much at all.   The NYT piece suggests this may be in part because Ben and Co. have been so convincing in their “we’ll-never-let-inflation-get-away-from-us” routine that prices are, in this sense, too well-anchored.  The hyper-responsible Fed would need to convince everyone, at least for a moment, that it was more reckless than it seems, and that’s hard to do.

But—and I’m agnostic about this—my impression is that it’s not a slam dunk that a lot more money-printing and bond buying would generate more demand and thus faster inflation.  For that, I actually think you’d need more real economic activity, more workers with more jobs and fatter paychecks, consumers with more incomes…that sort of thing.

It’s not that more QE wouldn’t move the needle at all—e.g., it’s been quite helpful in lowering the value of the dollar and thus helping our exports.  But I’d like hear more from advocates like Mark Thoma, cited in the piece, and with whom I was just hanging out in OR, on why he’s confident that the Fed could do this.

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16 comments in reply to "Suppose the Fed Wanted to Create More Inflation…Could They?"

  1. foosion says:

    Imagine the Fed adopted the helicopter drop strategy and gave everyone in the US $100,000. Most would spend it, increasing demand and therefore capacity utilization and employment, both directly and through subsequent rounds of purchases and hiring.

    Do you believe inflation would stay under 2%?

  2. foosion says:

    The Fed has emergency powers that let them do just about anything. They may have to agree to buy something from each person in order to comply technically.

  3. Peter K. says:

    My guess is that Professor Thoma would like the Fed to try even if it doesn’t work. They’ve been undershooting their inflation target. If more easing doesn’t work, that will make the case for fiscal stimulus stronger given that it’s the only option left. (It is odd that the stock market is up with slow growth. What we need is catch-up growth.)

    As you are probably aware Thoma writes regularly about the need for infrastructure spending. Good to hear you two were able to hang out.

  4. Kevin Rica says:

    The Japanese are great at manufacturing cameras and TV sets. But they certainly don’t know how to manufacture inflation.

    Maybe we should do a couple of structural changes, rather than trying to create an even larger excess demand for assets.

    Here’s two suggestions:

    1) Capital controls. End the dollar’s role as reserve currency. That reduces the excess demand for assets directly AND depreciates the dollar — making foreign goods more expensive and switching expenditure to U.S. goods.

    2) Increase the price of poor people. Really reform immigration and enforce restrictions and cut off the supply of low-skilled, low-wage workers that our economy does not need. This could add pennies to your weekly grocery bill. (You asked for inflation didn’t you?)

    At the end of the day, America would cease to be the place where cheap, surplus, Chinese capital met cheap, surplus, Central American labor.

    Walmart would not have such low prices and its customers would not have such low budgets.

  5. Dave says:

    The Fed could begin buying bonds from every citizen.
    Terms: 0% interest, principle due upon death.
    $250 per month from every man, woman and child.
    State that they will continue doing buying such bonds until the unemployment rate is below 5.5%

    Done deal. Economy fixed.

  6. Smiley Bob says:

    Wow, i am not an economist, but raising inflation seems like having the cart pull a horse.

    If you have no job, your salary is stagnant, or you are on a fixed income, why (or even how) would you be incentivized to spend more. (Especially when the current R’s are threatening all the life lines.)

    The best thing to do for the economy is to get the current R thinking out of the picture.

    • PJR says:

      Correct, many more jobs are needed, and this would lead to the inflation that we need rather than to inflation that we don’t want. The need for jobs has been staring us in the face for too many years now, but our dysfunctional government still won’t do anything about it. Economists, including those at the Fed, continue to offer offer ideas to compensate for political failure–these ideas are better than nothing, but they ought to be advertised (to voters) for what they are.

  7. Rima Regas says:

    Isn’t it true that QE is most effective when paired with stimulus but not by itself?

    • Jared Bernstein says:

      I’m not sure there’s much evidence for that but that’s very much my thinking–and Bernanke’s as well, as he’s been quite explicit about that connection.

  8. Marcus Nunes says:

    This was my comment on the NYT pice:

    There´s something unproductive about talking about inflation. You can set a different target!

  9. Leonard C. Tekaat says:

    The CPI does not measure the cause of inflation. It tracks the inflation rate of the inflation causes. The increase in the prices of assets creates equity which allows the financial sector with the fractional banking system create the excessive money (debt) that creates inflation. As asset prices rise it feeds upon itself, creating more and more money, and more and higher inflation rates. The way to control this process is not to increase interest rates but to reduce people’s desire to go into banks and take out a loan. The policy we should be using is the Zero Appreciation/Inflation Taxation Policy, when asset prices are increasing faster than the incomes of the middle class.
    The middle class is the back bone of our consumption economy. Their disposable income must be maintained to maintain prosperity and our standard of living. Our millitary and economic strength is derived from the taxation of the middle class and their ability to partisipate in the economy. The overhang of debt of the middle created by the financial crisis is depressing the economy. The Fed is re- inflating asset prices. This is not going to be a long term solution to our economy’s problems because the increase in asset prices is investor driven, not consumption derived. The middle class’s incomes are not rising to support the asset price increases. If the middle class is able to maintain their standard of living they will have to take on more debt, which will, if they can obtain it, work to increase GNP a little and for a short time, and then demand will fall. How do we create a sustainable economic recovery? Go to also read Economic Recovery-The Fed Can’t Do It Alone

  10. Stuart says:

    to Foosion and Dave: the Fed can’t buy bonds that don’t exist. I agree with Jared: the helicopter drop idea is fiscal, not monetary policy.

    Foosion: what emergency powers are you citing? The Fed can buy bonds available on the open market, and can sell bonds it owns, but it can always do that. Are you thinking of the Maiden Lane stuff? Or was there something else that I missed—always a possibility, so I’m just asking.

    To Peter K.: yes, Thoma writes a lot about infrastructure, and so do many others; I seem to recall reading a few words here at OTE on that issue. It seems so basic, and so clear, doesn’t it? With real interest rates below zero, with existing infrastructure crumbling, and with continued wide unemployment, it just seems like common sense to put the unemployed to work repairing out existing infrastructure. But of course, we need a lot more than that if we hope to continue to be a major economic power. We need investment in the infrastructure of the future, whatever that is. We used to invest in visionary infrastructure, and it has always paid off. But if you look for the biggest, or fastest, or tallest or longest or best of anything these days, you will find them elsewhere. The list of the 10 fastest trains in the world, for example, includes China, Japan, South Korea, Germany, even Spain, but we are not even close to making that list. Longest bridge? China has 4 of the top 5; Thailand has the other in the top five. The United States has the next two, but they were built in 1956 and 1970.

    We have a lot of work we need to do, and a lot of work we could do that would help us in our future. We have people and resources available to do it. Common sense, and hope, and vision, would all tell us to roll up our sleeves, borrow the money (at negative real interest rates), and get to work.

    But common sense isn’t really common, is it? It seems to be in short supply in the House.

  11. Dan Kervick says:

    Oh now you’ve done it Mr. Bernstein. Here we go again. Another two months of monetarist blog posts on Fed communications and credibility, expectations management via signaling, simultaneous causation and eerie causal loops, Vulcan mind melds, occult transmission mechanisms, the powerful emanations from central banker beard stroking, the faraway land over the rainbow that transcends the concrete steppes, etc.

    This doesn’t even get to the issue of whether increased inflation, or the expectation thereof, is a cause of improvement or a mere consequence of it.

    Anything to keep policy-making with the banking sector and prevent the spending arms of the government from doing anything serious.

  12. John Krehbiel says:

    It seems that you are saying that absent stimulus spending, the Fed may not be able to increase inflation under present circumstances. I am not an economist, but I think that is correct.

    But that does not address whether the target rate of inflation shouldn’t be higher, say 3 or 4 percent, once the current situation is past. It is my belief that much of the housing problem- people being upside down on mortgages- could be solved by 10 years of moderate (4-5%) inflation.