The reasoning was sound, but the methodology was faulty.

Food and energy bounce around much more than any other factor in the index.

They should have instituted some kind of rolling average for food and energy, rather than excluding them completely.

I like the counterintuitive insight that the Federal Reserve is running too tight of a monetary policy. I think Mr. Ponnuru is probably right and would like to see more discussions and analysis of monetary policy.

First of all, when I said, "inflation", I was referring to core inflation.

Second, to pretend that there are no discernible trends in the prices of fuel and food is ridiculous. There certainly are, regardless of the volatility of those goods over some others.

I think the differentiation between CPI and core CPI is unnecessary. Especially when the price of energy has such a significant impact on so much of what we purchase, especially food.

But I appreciate the textbook transcription nonetheless.

Bill Reilly - the statement that "normally cash would drop in a recovery as debt is paid down" is completely false as a matter of economic history.

The reality is that the portion of total assets held in cash and near cash forms (e.g. CDs) rises in recessions, always. Safety demand for money causes this. The demand for money as an asset form is counter cyclical and strongly so - it is not remotely a constant as some seem to think.

Total debts are a broader item than money or near money. The total debts of the financial sector *have* fallen about $3 trillion since the end of 2008. Part of that is debt repayment, another part is asset destruction through outright defaults and write offs, and another portion is just the evaporation of the asset backed securities market, which failed in the 2008 crisis. As loans of that form have matured, they have simply not been renewed, shrinking total credit outstanding.

The public sector and the Fed have added debt about as fast as the financial sector has reduced its debts, with essentially no net movement in total debts as a result.

But that net zero outcome is very far from being "normal" or typical, even of recessions. The normal behavior of the series for US financial sector total debt is to rise 14% per year, twice the rate of nominal economic growth, with about a 4% standard deviation from year to year. It can and does grow faster than the overall economy or total asset values, because financial intermediation has deepened with time - there are more layers of counterparty between the end borrower and the end owner, resulting in multiple counts for the same final-claim transaction.

That process of continual deepening of financial intermediation went into reverse in 2008, as many of the "off balance sheet vehicles" failed and were brought back onto balance sheets, asset backed forms were rejected by lenders, etc.

In the last 2 previous recessions, the financial sector debt series *bottomed* at a positive 6% per year rate of change. This time around, it went strongly negative, at 8-10% per year annual rates. The last time that happened was the early 1930s. Another way of expressing it is to say the financial debt series went to 6 standard deviations below its post WW II normal annual rate.

If the Fed hadn't added narrow money rapidly in the face of that private sector deflation, we would have seen a collapse of the broad price level. There is no econometric question about it. Commodity prices fell by 75% in late 2008 expecting exactly that. Everyone predicting broad inflation as a result of the Fed's actions has been completely wrong, and their predictions have generally been made in complete ignorance of the private financial sector developments the Fed has been reacting to and dealing with.

On that fundamental point, Mr. Ramesh is completely correct and the "inflationistas" bashing the Fed for its supposed looseness have been completely wrong.

Where I differ from Mr. Ramesh, however, is in his prescription. He thinks it is easy for the Fed to achieve stability in the supply and demand for money while also following a tight rule restricting its discretion, in the interest of making it more predictable for market participants. He doesn't seem to realize the two goals are in direct tension with each other.

When private banks shift from adding broad credit at 20% annual rates to reducing it at 10% annual rates within the space of 12 months - as they did from the end of 2007 to the end of 2008 - the Fed cannot stabilize supply and demand for money by sitting still. Demand soars in a crisis - but private supply of money substitutes moves violently, and does not directly respond to Fed actions.

To take another example, from the spring of 2005 to the spring of 2008, the Fed held M1 growth to *zero*, but the private banking system created over $2 trillion in net new credit. Much of which instantly became bad debts, since it merely goosed prices of already unsustainably priced assets, and ones that nobody could afford to finance at the 5% rates of the cycle peak. Standing on the brake for 3 years did stop the bubble - but it did not remotely do so smoothly or instantly or without major disruptions. In large part because the private financial sector "faded" Fed policy and continued to bet against it (expecting an inflation that was not materializing and could not with short rates at 5%) on an epic scale - and disasterously, for their own sakes.

I think most of the criticism directed at the Fed is and has been quite unfair to it. It is not remotely as omnipotent as those criticisms pretend, and even correct actions on its part, well timed, do not result in smooth adjustments of the whole financial system. Because everyone else involved - and there are lots of other actors involved - gets their own "vote" in such matters, and if they screw up their own jobs, the Fed cannot save them from the consequences.

By the way, that includes congress on the budget; the Bush treasury on its handling of the Lehman failure; the banks and their lending practices in the real estate bubble; players in that bubble signing loans they could not pay at crazy prices; speculators endlessly betting on a non-existent inflation - lots of bad decisions and mistaken policies, all around the table.

And pretending that if only the Fed restricted its discretion the results would be sweetness and light for all the dumb people doing collosally dumb things in their own domains, is pretending.

"I'm assuming you are a student"?

That's the safest assumption anyone's made in quite some time.

I would imagine the average person's problem is that your argument implies that if Big Bank A pays off a billion dollar debt to Big Bank B, the Federal Reserve should spring into action and hand a billion dollars to the federal government(or at least buy its bonds with printed money, keeping the yield artificially low). That, or it should allow Big Bank A to borrow another billion at a stupidly low rate.

Yes, this keeps the money supply consistent, but does it not have other effects that people may well object to?

I think that's people's real problem with the Fed-that its behavior transfers wealth from savers to the federal government, or the big banks. If the fed did nothing, then there would be deflation, and savers would be better off. The tools the Fed uses to prevent this instead make the government and the big banks better off.

(This is where you tell me my ignoramus self just doesn't understand that preventing deflation is the be-all and end-all. I know this is the theory, and it does not answer my point).

Whether or not it is currently doing so with political objectives in mind, and whether or not it is currently causing inflation, it is undeniable that the scenario of a government trying to print its way out of fiscal irresponsibility and thereby ruining the currency has happened many times, recently in Zimbabwe for instance. There's nothing inherent that says it can't happen here.

Ramesh, you are so utterly confused on monetary policy that it defies description. We have not had "tight" monetary policy since 2008. All you have to do is look at the dollar price of gold, which has inexorablly moved north. This can only happen when and if the supply of dollars outstrips the demand for dollars. It is that simple. Ergo $1760 gold.

Proper monetary policy would be based on a gold price rule, letting the dollar float within a very narrow band (say 2%) vis a vis gold. When the dollar price of gold moved to the upper end of the band, liquidity is extracted, when it moves to the lower end of the band, liquidity is added. In this way, the value of the currency is fixed and stable as it should be, just as the the value of an inch, a second and a quart are fixed.

Why in the world would you suggest a monetary policy where the value of the currency moves based upon the whims of intellectually inbred technocrats? It defies logic.

Ramesh, please school yourself in monetary economics. As a starting point I suggest Jude Wannisi's The Way the World Works and Nathan Lewis' Gold: The Once and Future Money. The New York Sun editorial page is outstanding also, as are anything by Louis Woodhill, John Tamny, Lew Lehrman, Charled Kadlec, Paul Hoffmeister and Vlad Signorelli. Plus, of course, the late great Wanniski.

You have tied yourself in such knots on this stuff that it is becoming painful to read.

What other condition or situation would make the dollar price of gold move higher?

Funny to see the Post sounder on economics than an NR senior editor. The Post editors are entirely correct to point out that there's no shortage of cash, and that "the private sector still hasn’t discovered the next big sources of profits and job creation". In other words, private parties are rationally sitting on cash because there are not sufficient positive-net-present-value investment opportunities. In those circumstances, trying to manipulate them into spending or investing, as Ramesh would do, will only result in new malinvestment and bubbles.