Paul Krugman criticizes Fed chief Ben Bernanke in todays New York Times magazine. Krugman thinks Bernanke hasnt done enough to end "mass suffering for American workers." He thinks the cure is higher inflation:
If the Fed were to raise its target for inflation — and if investors believed in the new target — expected inflation over the medium term, say the next 10 years, would be higher. . . . [H]igher expected inflation would aid [the] economy . . . because it would help persuade investors and businesses alike that sitting on cash is a bad idea.
Well, it worked for the Weimar Republic.
Okay, okay, sorry, sorry; Ill let myself out.
But there are reasons why Krugmans theory may not work. A first problem is Krugmans lack of concern with the inflation we already have.
Krugman says inflation worriers are wrong to focus on broader prices and should focus on "core" inflation (the cost of things excluding energy and food). The flaw in this thinking is that energy and food prices matter. If people expect the price of gasoline to keep going up, theyll take this expectation into account when purchasing a house. The more you spend on gas every month to get to that house from your job, the less you can pay for the house.
And these natural-resources prices do have to do with American monetary and fiscal policy. Much of the Wests stimulus leaked overseas, helping developing countries to push resource prices even higher in their quest to sell us stuff and to buy stuff themselves with the cash we pay them.
A second problem has to do further with Krugmans expectations of other peoples expectations.
Krugman thinks it should stand to reason that if I — whether I am a middle-class saver or a huge multinational corporate executive — have extra money lying around, and Im scared that inflation will eat away at the value of that money, I would rather go out and buy a new hat or a stock portfolio or build a new factory rather than see that loss of value happen. Such activity would jump-start the economy and all would be well.
But people may not behave the way the money-thought-planners would have them behave. A person or company worried about the value of the dollar could instead insist on holding only short-term obligations — rather than 30-year bonds, three-month or one-month bills.
Such a shift in demand would destabilize the economy rather than fix it. Borrowers would find themselves even more dependent on the vagaries of short-term credit markets. Bank-watchers might worry that financial institutions would have trouble rolling over their short-term debt, precipitating another financial crisis.
Such worry could cause people and businesses to hold even more cash, not less — spurring them to cut spending.
Non-financial companies are still hoarding so much cash in checking and savings accounts — nearly $1.3 trillion today, up from $590 billion in 2007 — partly because their managers suspect that the financial system is still broken and held together only with record-low interest rates. They find comfort in cash. Destabilizing already-fragile expectations would exacerbate this fear, not calm it.
A third reason has to do with the Fed itself.
The Fed buys bonds when it wants interest rates to stay low (and when it possibly wants to tolerate higher inflation) and sells bonds when it wants interest rates to rise.
Since January 2007 (around when the financial crisis began for the people who were paying attention), the Fed has been buying a lot of bonds. The amount of the assets that the Fed holds has grown more than threefold, from less than $1 trillion to nearly $2.9 trillion.
This growth means that the Fed has become the story. The Fed now holds nearly $861 billion worth of mortgage-backed securities, or roughly 9 percent of American mortgage debt.
This is huge. A person thinking about buying a house shouldnt say, "gee, rates are low. I should act now." What he or she should say is, "gee, rates are low because of the Feds extraordinary actions over the past few years. What will happen to the value of the house I might buy when the Fed stops? Maybe I should hold off buying, and wait and see."
The more the Fed interferes in markets, the more time people must spend watching the Fed rather than making sound economic decisions.
And the longer interest rates stay at record lows, the more people must worry about what will happen when rates go up.
Original Source: http://www.nationalreview.com/corner/297218/krugman-nicole-gelinas