“This crazy world…is coming undone”

Or, and this from a prominent former FOMCer Narayana Kocherlakota, “When Discredited Policies Make Sense”:

Presidential candidates Donald Trump and Bernie Sanders have proposed policies that run counter to literally centuries of economic thought. In the current environment of extremely low interest rates and low inflation, however, they might make more sense than most economists recognize.

The Federal Reserve faces a big challenge: It wants to get inflation up to its 2-percent target, but so far its stimulus efforts have failed to reach that goal. So there’s a good chance it will keep interest rates low, even if inflation pressures pick up a bit. This likely passivity of monetary policy creates a highly unusual situation, in which certain much-discussed economic initiatives could have an unusually positive effect.

So, monetary policy has been “passively” tightening. Market Monetarists agree with that. Kocherlakota hopes (in vain) that monetary policy will remain “passive”, but in “stimulating fashion”.

For example, he argues:

  • Increasing the minimum wage. What if Congress decided to increase the federal minimum wage by 10 percent a year over the next five years? Typically, economists would be concerned about the impact on employment: Higher wages might lead businesses to employ fewer workers. With monetary policy out of the picture, though, the move might actually help. The expectation of higher wages would cause consumers to expect more inflation over the next few years, leading them to buy more goods and services now, before prices went up. To meet this added demand, businesses would have to boost production and hiring.

Similar reasoning for other ‘favorited” measures:

Increasing import tariffs, and Imposing restrictions on immigration.

Recognizing that:

The Fed’s response is crucial in all these cases. Typically, the central bank reacts to increases in inflation by raising interest rates sharply — a move that would choke off any demand that the policy measures might generate. With inflation running well below target, however, it’s appropriate for the Fed to hold rates low even if it sees a modest increase in inflationary pressures. It’s this subdued reaction function that allows the policy initiatives to have more positive effects.

It´s the sort of argument that will be eagerly embraced by the “End the Fed crowd”!

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3 thoughts on ““This crazy world…is coming undone”

  1. Sure… Bernie and Donald could team up to create a bunch of supply shocks to help the Fed hit its inflation target. What a grand idea… God, help us…

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