Without meaning to, he defends an NGDP Level Target!

Edward lambert at Angry Bear writes: “Inflation expectations, income expectations & financial repression

The Federal Reserve Bank of San Francisco published a letter titled, Consumer Inflation Views in Three Countrieswritten by Bharat Trehan and Maura Lynch. The letter explores inflation expectations among consumers in the UK, US and Japan. Basically the story is that inflation expectations by consumers are tied to the level of oil prices and recent inflation. Policy adjustments by a central bank do not play much of a role in determining their inflation expectations.

The inflation expectations of consumers are important to evaluate the spending and wage demands of consumers. If consumers raise their inflation expectations, they would bargain for higher wages, only if they have power to do so. Labor has little power nowadays to bargain for better wages.

So what the letter from the FRBSF is missing is a comparison between what consumers expect of inflation and what they expect from their own incomes. Simply put, if I expect inflation to be 3%, but expect my own income to rise at around 0%, then I feel I am losing ground… and I will be less likely to spend money. Surely it makes more sense to spend money now since prices are rising faster than I can keep up with them, right? No… Spending more money now would make me feel even more insecure.

Solution: Give them reason to expect higher incomes going forward. Adopt an NGDP level target!

But EL goes ‘ballistic’ and proposes an increase in interest rates:

If the Fed was to raise their interest rate, the return on savings for consumers would go up, and consumers would feel a bit more empowered to spend. Of course, the government would have to pay more to service its debt, but consumers would feel secure to spend more. Thus, we see a form of financial repression at work which has the effect of suppressing consumer spending to the advantage of the government and owners of capital.

This is a version of Kocherlakota´s 2010 argument that if rates remained low, deflation would set in! Some think that for getting that sort of advice Kocherlakota fired some of his advisors!

2 thoughts on “Without meaning to, he defends an NGDP Level Target!

  1. If rates remain low, deflation will not set in. Businesses are controlling the prices for profit. They have market power. Real GDP will simply be suppressed while profits are being maximized.
    The economy is now reaching the effective demand limit. In that situation, businesses crowd each other out for profits. For instance, if one company makes more profit, another company loses profit. We now have a situation where businesses are competing on price. In the past, wages would start to rise at this point in a business cycle, but that is not going to happen this time due to high unemployment and no bargaining power.
    Rates will remain low, Real GDP will remain low… Real income will remain low… and prices have come down due to market power of firms to do so.

    As far as NGPD targeting, I do not agree with that approach. It would shove the economy head on into the top of the business cycle with to much momentum.

  2. Edward Lambert’s commentary and posted comment here,,,where to start?

    How about this: How can the Fed raise interest rates? The problem now is huge amounts of capital on the sidelines, yet slow growth. There is not enough demand for capital. Add on, inflation has been dead for years.

    So rates are going to be low. Lenders have no demand for their commodity, and they know inflation is dead. Rates stay low.

    The Fed could “tighten” and do less QE. This would probably drive down asset prices, especially property, leading to slower economic growth and less demand for capital.

    And as of consumers, higher interest rates also mean higher bills on debts.

    I think Edward Lambert needs to re-think this….

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