While Yellen speaks of the “suffering economy”, Feldstein is worried about future inflation

Yellen:

Underscored how the jobs lost in the wake of the 2008 financial crisis have yet to come back, and have left millions suffering in the aftermath.

Feldstein:

Janet Yellen, like Ben Bernanke before her, believes that the Federal Reserve should communicate the reasons for its current policies and the strategy of its future policy actions. And so we have been told the basic plans are for gradually reducing the volume of large-scale asset purchases, and for keeping short-term interest rates low—”for some time,” as she said in her speech on Monday—in order to stimulate employment and raise the inflation rate toward 2%.

But the Fed’s leaders should also be telling the public and financial markets what they think about the risk that future inflation could rise substantially above the Fed’s 2% target—and what the Fed would do to prevent such inflation or reverse it if that occurs.

Experience shows that inflation can rise very rapidly. The current consumer-price-index inflation rate of 1.1% is similar to the 1.2% average inflation rate in the first half of the 1960s. Inflation then rose quickly to 5.5% at the end of that decade and to 9% five years later. That surge was not due to oil prices, which remained under $3 per barrel until 1973.

Yes, it can. But not while spending growth at present is less than half the rate of spending growth in the 1960s! In addition, there´s a wide spending “hole” which was opened up in 2008-09 and never “filled”!

Feldstein_1

8 thoughts on “While Yellen speaks of the “suffering economy”, Feldstein is worried about future inflation

  1. Pingback: Yellen’s “suffering economy” vs Feldstein’s concern about future inflation | The Corner

  2. Martin Feldstein:
    “…Experience shows that inflation can rise very rapidly. The current consumer-price-index inflation rate of 1.1% is similar to the 1.2% average inflation rate in the first half of the 1960s. Inflation then rose quickly to 5.5% at the end of that decade and to 9% five years later. That surge was not due to oil prices, which remained under $3 per barrel until 1973.

    Although history teaches that a rapid expansion of the money supply leads eventually to rising inflation, the current inflation risk is not, as many people assume, that the Fed’s policy of quantitative easing has greatly expanded the money supply. Although the commercial banks received trillions of dollars of reserves in exchange for the assets that they sold to the Fed, these reserves were not converted into money balances but were deposited at the Federal Reserve, which now pays interest on such excess reserves. The broad money supply (M2) increased only about 6% in the past year.

    The real source of the inflation risk is that the commercial banks can use their enormous deposits at the Fed to start lending when corporate borrowers with good credit ratings are prepared to borrow. That increase in lending to businesses will be welcomed until the economy is back at full employment…”

    I’ve heard variations of this complaint from everyone from Richard Koo to believers in ABCT. The basic idea seems to be that the money multiplier is highly volatile and that the moment short term interest rates leave the zero lower bound inflation is going fly out of control because lending will go through the roof.

    This seems extremely unlikely if you consider the last time the Federal Reserve spent a protracted period at the zero lower bound. Here’s a graph of the Friedman and Schwartz M2 money multiplier and the yield on short term (3 to 6 month) U.S. securities from 1925-70 (I can’t use the original FRED graph right now because the new FRED is still experiencing teething pains):

    The money multiplier reached a low of 2.52 in November 1940 when short term interest rates were 0.003%. After the Fed un-pegged the short term rates from the 0.375% rate that had been set from mid-1942 through mid-1947, they were allowed to rise above 1% in August 1948 for the first time since March 1932. But the money multiplier remained close to three, rising only very slowly even as short term interest rates rose high enough by 1953 to resume their more familiar cyclical volatility.

    Note that this slow rise in the money multiplier continued on through the 1960s. What changed in the 1960s was the Fed started increasing the monetary base in 1962 after a decade of it being nearly constant at about $50 billion. This combined with gradually accelerating money velocity led to rapid NGDP growth, consistently above 5% annually from 1963-70 and consistently above 8% annually from 1971-81.

    The perception that inflation “suddenly accelerated” in the last half of the 1960s is mostly due to the fact the US economy hit the vertical portion of the short run AS curve as the unemployment rate dropped to 3.5% during a time when full employment was closer to about 6% mostly due to demographics (a tidal wave of young inexperienced and relatively unemployable baby boomers started entering the labor force).

    In any case, the bottom line is that neither the money multiplier, nor money velocity, behaved in an unpredictable fashion in the 1960s. The Fed just “printed” more money than was necessary or desirable.

  3. Pingback: TheMoneyIllusion » Let’s play 1960s-era Fed

  4. OK, we get the point that now is not the time to worry about the Fed’s balance sheet causing inflation. But, I read Feldstein as saying in part “Hey, you inflation doves, just show us how either a) the $4 Tril monetary base will NEVER be a problem or b) that the Fed has all the ammunition it needs to shrink the base as fast as it may need to once we get back to potential output.” Do people really think that the price level is now and forever totally de-linked from the monetary base? That’s what I hear whenever someone (like Krugman for instance) says “silly inflationista – go hame and play with your broken macro models by yourself.”

    Also, I have to ask: isn’t that a rather bogus potential GDP trendline? Do you really want to claim we were running below capacity in 2007? Wasn’t there a housing BUBBLE? Plus, do you deny that potential GDP took a hit during the recession? FRED’s potential GDP trend doesn’t look anything like your line. Even a linear trend of NGDP from 2000 to 2007 is much flatter than what you show. And keep in mind that there was plenty of middle east war spending happening in 2000 to 2007 so that time frame may well overstate our current growth potential. There is just no way the output gap is as big as you want us to believe. And it makes little sense to believe the gap between potential GDP and actual GDP will widen year after year forever. The conventional potential GDP data shows the output gap narrowing – too slowly for anyone’s liking but, narrowing nonetheless and that makes Feldstein look a tiny bit less like the boy who cried wolf. And remember – the wolf really did show up eventually.

  5. Pingback: スコット・サムナー「60年代との共通点はどこ?」 — 経済学101

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