David Beckworth has offered a thoughtful, but I believe ultimately flawed, “conservative case” for the Federal Reserve’s latest round of quantitative easing. While I wholeheartedly share Professor Beckworth’s desire to see the economy improve, and share his concerns that if it does not we may end up with expanded government spending, it is hard to see QE2 as providing the environment of certainty the private sector needs in order to expand.
Professor Beckworth should be commended for clearly spelling out his assumptions. Public debate would be far more fruitful if others did the same. Let’s start with his core assumption: Because the monetary base has been expanding and there’s been little inflation and little increase in consumption, households must be hoarding money. The logic in this case is sound; I disagree with the facts.
First, the good professor argues that spending is far below trend. That is true enough as it goes, but this trend includes a massive housing bubble, where imaginary wealth fueled spending, aided by massive borrowing from abroad. The objective of our economic policies should not be to get back to the top of the previous bubble. It was this desire to replace the lost wealth of the dot-com crash that contributed to the Fed’s juicing of the housing market. All that said, consumption today is higher than at any time during the recent bubble. The primary problem facing our economy is not a lack of demand.
Like Ben Bernanke, Beckworth believes we have had no inflation. Again like the Fed, he arrives at this conclusion by subtracting out of the inflation numbers all the things that real people spend their money on, such as food and energy. I would not claim we are facing hyper-inflation, but two facts should be borne in mind. First, over time even low levels of inflation erode away wealth; and second, a large surge of inflation is likely to occur quite suddenly, without giving the Fed months or years of warning.
Finally, the good professor fails to consider that households may not be “hoarding” cash by choice. After all, most of us still have our cash in banks, even if in transaction accounts. The money hasn’t been stuffed under the mattress. In fact, throughout this recession and financial crisis, the amount of insured deposits has been consistently increasing. We are nowhere near a 1930s style disintermediation of the banking sector, which greatly contributed to an actual decline in the money supply during the Great Depression. Most market participants, me included, would be happy to put their money into valuable investments. Yet with interest rates near zero, there’s little incentive not to hold cash balances, as the opportunity costs are nonexistent.
If Beckworth wants to preach “conservative” values and principles, he might start with the observation that it is savings and work that provide wealth, and reject the Keynesian notions that we can spend or debase our way to prosperity.
— Mark A. Calabria is director of financial-regulation studies at the Cato Institute.
"Like Ben Bernanke, Beckworth believes we have had no inflation. Again like the Fed, he arrives at this conclusion by subtracting out of the inflation numbers all the things that real people spend their money on, such as food and energy."
This is incorrect. Including price of food and fuel the calculations would decrease the inflation rate for 2009 into negative territory. Including it for 2010 would increase the inflation rate from .6% to 1.2%, which is still below the Fed's 2% target.
Reply to this commentLinkReport AbuseGovernment officials of both parties routinely cite CPI figures to quantify monthly and annual rates of inflation. Bernanke and Beckworth may cling to a belief that there is no current inflation, but this is a falsehood. The market basket used to calculate the CPI is fundamentally flawed, in that it does not take into account the massive increase in the cost of government to individuals these past decades. We lie to our seniors when we give them a paltry point or two increase in Social Security, taking it back in higher taxes or inflated money, and we lie to the markets when we tell them there is no inflation and the dollar is secure.
With the US poised to embark on more jobs-killing taxation at year's end, this will have an added result of increasing costs for us all, directly or indirectly.
Reply to this commentLinkReport AbuseHere's Milton Friedman in December of 2000:
David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?
Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.
The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.
During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasi recession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high-powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.
Reply to this commentLinkReport Abuse"This is incorrect. Including price of food and fuel the calculations would decrease the inflation rate for 2009 into negative territory. Including it for 2010 would increase the inflation rate from .6% to 1.2%, which is still below the Fed's 2% target."
In November of 2008 oil was at $41 a barrel; corn was below $6 a bushel. Today oil is over $80 and corn in the US sells over $8, and $10 in China. The money supply has increased over $2 trillion in 2 years. Yes, there is inflaton.
The CPI is heavily weighted with real estate. Depreciating real estate prices skew the CPI numbers. Thus far, suppliers of food products have absorbed the price increase in wheat, beans, corn, and other grains. They've done it through lower margins; but, that cannot go on forever. Wal-Mart, one of the largest distributors of food in North America reported in October that wholesale commodity costs of its suppliers have risen around 14% year over year. At some point in the near future, these inflation has to passed on to consumers. Of course, the CPI will never relfect these costs because food and energy are discoutned.
Falling asset prices in real estate may not mean much to a couple who can still make mortgage payments; but they mean everything to a bank which must mark down its equity month after month. The Fed cannot supply enough cash to offset falling rea estate prices. We should remember that while real estate isn't liquid, it does get tallied up as an asset in a bank's GL. The less hard assets a banks has, the more cash it must keep on hand. When the real estate market bottoms out and begins to recover, our banks will recover; credit will return, and businesses can grow. This recession began with a crisis in real estate and mortgages. A real sustained recovery will begin there as well.
Reply to this commentLinkReport AbuseJPK,
You say: "In November of 2008 oil was at $41 a barrel; corn was below $6 a bushel. Today oil is over $80 and corn in the US sells over $8, and $10 in China."
In June of 2008 oil was $125 a barrel. It's up from where it bottomed out but still much lower than where it was before the crisis.
And corn is $5.65 a bushel, not $8.
Reply to this commentLinkReport AbuseBTW, it's simply not true that the CPI doesn't include food and fuel. There is a "core inflation" number that doesn't include food and fuel because these prices are so volatile. Regular CPI, however, does include food and fuel. And as I pointed out in my initial comment, in 2009 the core inflation number was *higher* than the regular inflation number, and even now including food and fuel only gives you at inflation rate of 1.2%, which is below the Fed's 2% target.
Reply to this commentLinkReport AbuseI find this response to Beckworth very disappointing.
Expanding the productive capacity of the economy is very important, however, the best environment for microeconomic adjustment is for the flow money expenditures to grow along with the productive capacity of the economy. If the flow of money expenditures should fall, the only way to maintain the flow of real expenditures is for the price level (including money wages) to fall. Fortunately, there is no need to suffer such a deflation, quantitative easing makes it possible to keep money expenditures growing with the productive capacity of the economy.
While I believe there was a housing bubble in 2006 or so, the bubble means that spending on some goods was too high (now homes), but that spending on other goods was too low (exports or capital goods.) The production of some goods may have been too high, like single family homes, but the production of other goods, like export goods or capital goods, was too low.
While Calabri explicitly rejects Keynesian economics, he implicitly adopts the most naive version of Keynesian economics. Think about it. He is explaining the level of production in the U.S. economy in 2007 by high spending.
Basic free market economics would explain the level of output in 2007 by productive capacity--the willingness of people to work, the capital goods that have been built up, and technological know how. But were does the spending come from to buy all of the products? Supply creates its own demand. People sell these goods to earn incomes and they earn incomes to buy these goods. But what about saving? Well, interest rates adjust so that when people save signals and incentives are generated so that firms purchase capital goods.
Beckworth not only understands these arguments, they are fundamental to his approach. But, there is a complication. What happens when people earn income and choose to increase their money balances? Most money is "in banks." It is the creation of banks. If the quantity of money fails to rise to match the increase in demand, they total spending in the economy will not match the productive capacity of the economy. And that is where we are today.
Reply to this commentLinkReport Abuseyour arguments against inflation figures are:
A) inflation even at low levels erodes wealth
and
B) high inflation is likely to happen suddenly.
That is the crux of your argument?
wow.
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