In today´s Fiscal Times, Bruce Bartlett has a piece with a catchy title: 7 Reasons the Fed Should Raise Interest Rates…
…and Still Keep Easy Money Flowing through the Economy
And after detailing his 7 reasons, he concludes:
So how is it possible to raise interest rates without tightening monetary policy? The answer is surprisingly simple – raise inflationary expectations. According to economic theory, lenders are mainly concerned about the real rate of interest – the market rate minus the expected rate of inflation over the life of a loan. If expectations of inflation rise, then interest rates should rise by the same rate.
The Fed can raise inflationary expectations just by saying that it intends to allow inflation to rise. If markets believe the Fed means it, they will react accordingly because they know that the Fed is the principal cause of inflation.
There are two main problems with instituting this simple policy change. First, there is very fierce resistance to higher inflation among members of the Federal Open Market Committee, the Fed’s policymaking arm. They will make it as difficult as possible for the Fed to explicitly raise its inflation target and sow as much doubt as possible in financial markets that it really means it, which will frustrate the goal of the policy.
Second, some economists have serious doubt as to whether the Fed is capable of raising inflation under current economic conditions even if it wants to. As we have seen over the last several years, even massive, unprecedented increases in the money supply have had no effect on inflation; indeed it has actually fallen. However, Federal Reserve Chairman Ben Bernanke has repeatedly dismissed this argument, saying the Fed has plenty of ammunition left.
In a future column I plan to explain why fears of future inflation are misplaced and why the risk of doing what I have suggested here is very small – well less than a policy of doing nothing and allowing our economic problems to fester.
Back in October 2011 Bruce Bartlett wrote and talked about NGDP targeting. In a CNBC interview at the time he criticized the Fed for “sitting on its hands” and argued it could spur aggregate demand if it adopted a nominal GDP level target.
I have no idea why he switched to talking about inflation expectations and how they have to be raised. The word inflation is a debate stopper and BB will never be able to assuage people´s fears of future inflation. He should have stuck to NGDP targeting, because that´s exactly what he means.