« Asset-Price Bubbles—Posner | Main | Central Bank Independence-Becker »

05/23/2010

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Kevin

"But occasional proposals, as by Milton Friedman, to tie the Fed to a precise formula for increasing or decreasing short-term interest rates seem too rigid, because a formula cannot prescribe the correct response to unpredictable shocks to the economy, as we experienced in the financial collapse of 2008."

I think Friedman would agree, but argue there wouldn't be as many problematic shocks if the money supply grew at a constant rate. Even you agree that the Fed's decision to use expansionary monetary policy too aggressively in the 2000's contributed to the collapse.

Gordon Longhouse

These days central bank independence of a greater or lesser degree is almost taken for granted.

More controversial is the issue of whether the central bank should only seek to manage consumer price inflation, asset price inflation or both.

Also should it wait for inflation to take hold or should it act when it anticipates that inflation will happen if it fails to act?

Alan Greenspan continues to maintain that a central banker can only act against rises in the CPI after they take place.

The Reserve Bank of Australia has raised interest rates to counter what it thought were asset price bubbles even when inflation was within its 3% per annum target. (This target is set by agreement between the Treasurer, a cabinet appointment, and the RBA head). I wold suggest that the RBA practice is the better.

When it does this it cops considerable criticism from politicians trying to distance themselves from the consequences for their constituents.

Ideally the rise and fall of interest rates would be looked upon in political terms as a natural phenomenon like the rise and fall of temperatures and therefore mostly out of the control of the political process. I do not see this happening anytime soon so central bankers will continue to have to account for themselves to politicians as the quid pro quo for their de facto independence.

Michael F. Martin

"When Paul Volcker, the chairman of the Federal Reserve, pushed short-term interest rates to 20 percent in August 1981 to break an inflation rate that had reached 15 percent, he precipitated a very sharp recession. President Reagan was furious but Volcker stuck to his guns."

I worry less that Bernanke will not have the nerve than I do that he will not be able to act as quickly. Will the Fed have actionable data that inflation has set in before it is too late? Six months ago, there was a trillion in the reserve system. Now that trillion is mostly in corporate cash accounts. There appears to be nothing stopping the financial services industry from rapidly, and simultanesouly, raising lending rates to pull the cash back into the banking system.

Don the libertarian Democrat

"But occasional proposals, as by Milton Friedman, to tie the Fed to a precise formula for increasing or decreasing short-term interest rates seem too rigid, because a formula cannot prescribe the correct response to unpredictable shocks to the economy, as we experienced in the financial collapse of 2008."

That's fine, but I still think his view here, if used in conjunction with his other suggestions for Economic and Monetary Stability, would work well, and not need as much fine tuning as thought.

Jack

The Carter/Volcker/early Reagan era was a confusing time. I'm not at all sure Volcker (who I generally like) did the right thing.

The true "inflation" must have been earlier and among the reasons we were forced off the gold standard. Nixon tried wage/price controls to restrain the predictable adjustments but they just as predictably failed. OPEC then wanted oil repriced in some relationship to gold or their own currency. R/E and other hard assets were similarly repriced, with boomer demand adding fuel to housing prices.

At the time I thought it was silly to raise interest rates in response to an outside price increase in oil that we could not or were unwilling to change. In many instances the high interest just added more costs to doing business on top of the cost push of oil prices resulting in yet higher prices.

While the Carter admin responded with demand lowering policies including CAFE standards, lowering the speed limits etc. those may not have been enough to have broken OPEC's pricing, but oil prices did tank and stay down for quite a long time. Did we create a steep recession to crack OPEC?

Today there is all this fear of lighting off an inflationary trend. But, after tallying up Fed injections and the deficits we should consider the other side of the equation such as the amount of money supply that is no longer in housing equity, stock market losses, and loss of entire incomes for many. Also we'd want to reflect on the combo of very low inflation during the high employment era of the 90's.

With 10% or more of our people on the sidelines, seeking, and needing jobs, along with the near infinite supply of offshore labor that was surely a factor in being able to run the nation at 5% unemployment without triggering inflation, I doubt inflation is our main problem.

Having the Fed try to respond to asset pricing seems a nightmare. Consider, (when the system isn't broken!) higher prices for commercial, rental or residential homes are the trigger to build more of them; classical economics at work. Tightening lending would simply slow the response. As for tightening on prospective oversupply that's exactly the job of local lenders and builders. The wisdom of a capitalist market has got to be left to investors and lenders taking their best shot. (Just don't let 'em get too big!)

Russell

It is plain as the nose on your face that the Fed has done a poor job of managing the money supply this decade. In fact, it has yet to be explained in a cogent way how the Fed can know what the appropriate interest rate is.

The mere fact that prices are flat does not mean there is no inflation. To the exent that prices should be falling because of more efficient manufacturing or production (say, like with computers or LCD TVs) or because of excess production like in residential or commercial real estate and are not falling is a reflection of inflation, inflation by the Fed pumping money into the economy. Inflation robs value from savers and creditors. Why is that honest or good. Why do we need inflation other than to feed a debt addicted economy?

If we don't need inflation, then we don't need a Federal reserve. Just maintain a static money supply and let supply and demand adjust prices. Then we don't have to worry about an independent or politicized Fed doing the wrong thing. Short of that, there should be complete transparency as Gary Becker suggested.

Jack

Russ, some good points: "The mere fact that prices are flat does not mean there is no inflation. To the exent that prices should be falling because of more efficient manufacturing or production (say, like with computers or LCD TVs)"

........... and they have done so! And perhaps? with all the increased productivity wages for working folks SHOULD have risen substantially, but! all the gains have accrued to the top 10% giving most the fairly accurate feeling they are treading water.

"because of excess production like in residential or commercial real estate and are not falling is a reflection of inflation,"

........... as home building is a risky and typically thin margin operation prices of NEW homes can not drop much; if they do the reaction of (rational) home builders and (rational) bankers is that of not building. Used homes are likely to bear most of the brunt of a falling market as the individual seller may have A. an urgent reason to sell -- job change, loss of one or more incomes, divorce, and B. have equity or be forced to take a short sale.

Not sure why you conclude the Fed's is typically in the biz of "creating INflation" as most often they're in the news for rightfully or wrongfully standing on the brakes.

And Ha! if you don't like the Fed trying to prop up what's left of our economy, I suggest reading or considering what it's like to live in the downward spiral of a deflationary era. Our system isn't set up to deal with deflation very well.

Chris Graves

I have to disagree with Judge Posner on his skepticism toward instituting a monetary rule. I also disagree with his depiction of the role that President Reagan played in Paul Volcker's efforts to bring the money supply under control, and inflation with it. First, Reagan did offer public support for Fed Chairman Volcker's inflation-fighting monetary policy. Here is a link to an article by Robert Samuelson recounting Reagan's role in offering support for Volcker's tight monetary policy even though he certainly was wary of the short-term political consequences of Volcker's policy.

http://www.slate.com/discuss/forums/thread/2232562.aspx

Later, Reagan appointees to the Fed led by Wayne Angell did vote to challenge Volcker. The thinking by the mid-1980's in the Reagan Administration might have been that inflation was then under control and the Fed needed to engage in a more expansionary monetary policy for the sake of the 1986 election. Of course, that was a mistake by the critics of Volcker in the Reagan Administration.

This series of events set in motion the appointment of Alan Greenspan who tried to iron out the business cycle by following short-term inflationary policies to counter economic downturns and then raise interest rates to head off inflation if and only if there was significant upward movement in the general price level. Greenspan's policy set the stage for the 2008 financial meltdown as he built up a series of bubbles during his tenure leading the Fed. Inflationary policies simply do not work even when a very insightful and experienced Fed Chairman follows what he believes to be carefully balanced counter-cyclical discretionary monetary policy. There is no way to accurately detect and measure inflation as it is occurring until it is too late.

So, discretionary policies simply do not work in the long-run. Rather, they head off the day of reckoning as Fed Chairmen decide that re-inflating the economy is more responsible and less harmful than taking a massive recession to purge inflation as Volcker did in the 1980's. Even conservatives such as Judge Posner and Professor Becker have argued against the horrors of recession and depression during the recent financial crisis rather than following a Volckeresque policy to restore financial stability through regularizing the growth in the money supply.

Of course, what we are doing now is re-inflating as we sow the seeds of an even more dramatic financial failure later. A steady monetary rule would head off these problems in the first place as Kevin and other commentators have pointed out above. But, let us be aware that it is likely that a monetary rule would lead to slower growth than what we have grown accustomed to in this age of Keynesian discretionary policies that are based on inflation. The big payoff of a slower and more predictable rate of monetary growth is sustainability.

Darko Oracic

The 2008 crisis was caused by Fed's contractionary policy. In 2006 and 2007 money supply (M1) growth became negative and short-term interest rates became higher than long-term interest rates. That created a credit crunch and a recession. A monetary rule that would not allow the Fed to reduce money supply growth below a limit or to raise short-term interest rates above a limit, would prevent such a crisis.

Trent Rock

" ....and very few people have even the slightest understanding of the Fed’s role and responsibilities"
Hahahahah..when I was in college. I asked my fellow econ students if they knew who Alan Greenspan was. Most did not :(


I'm with Posner on this issue. Especially the electoral cycle part.

Robert

The first issue to be considered here is whether there is even a need for a central bank. For nearly the first 125 years of its life the Nation did not have such an institution. Instead, in times of financial crisis smaller banks were supported by bigger ones. Contrarily, within 20 years of the Federal Reserve coming into existence the Great Depression rocked the economies of America and the West; real recovery did not begin until World War II. Nowadays, the Fed decides to "warm" or "cool" the economy by tinkering with the money supply. But it certainly got that wrong in the early 2000's with low interest rates leading to a housing bubble and the calamitous events of September, 2008. Why do we allow a bunch of elites to have this much power over the economy with limited accountability for their mismanagement? Doing away with the Fed might solve the problem.

coach purses

Your blog is wonderful. I think more people need to read blogs like this. It's pretty much impressive to me. Looking forward to another great article.

lacoste shoes 2010

nothing in the world is impossible if you set your mind to do it.

sesli chat

It is plain as the nose on your face that the Fed has done a poor job of managing the money supply this decade. In fact, it has yet to be explained in a cogent way how the Fed can know what the appropriate interest rate is.

nfl jerseys

Maxine Waters lamented that the chickens were now coming home to roost for the Democratic Party, a Party that accepted these disloyal representatives into their fold for the sake of power. And you know what? She is right. This is what happens when you pitch a big tent and let anyone and everyone in simply to bolster your numbers. You might gain the numbers you need to be in control technically, but if a big enough portion of your membership does not go along with the leaders and are constantly striking out on their own then that power can be quickly neutered.

http://www.epayebuy.com/cleveland-browns-white-nfl-throwback-jerseys-32-jim-brown-p-225.html

oil paintings

Well said, such a person should be a good sentence, or the future will be more rampant.will be happy to be proved wrong with this I have to admit to a raised eyebrow with this as well.

Supra Shoes

Your blog is too good-looking,I like it very much,hope your new articles.

burberry outlet

I love my oven because I can bake all I want, My oven is very large, sometimes I can bake several recipes to the same time and it saves me time. Really

helpful.

lower back pain

Now that trillion is mostly in corporate cash accounts. There appears to be nothing stopping the financial services industry from rapidly, and simultanesouly, raising lending rates to pull the cash back into the banking system.

directx 11 download

Dreamin. I love blogging. You all express your feelings the right way, because they are your feeling, focus on your blog it is great.

Shelia

I worry less that Bernanke will not have the nerve than I do that he will not be able to act as quickly. Will the Fed have actionable data that inflation has set in before it is too late? Six months ago, there was a trillion in the reserve system. Now that trillion is mostly in corporate cash accounts. There appears to be nothing stopping the financial services industry from rapidly, and simultanesouly, raising lending rates to pull the cash back into the banking system.

Share laptopz.com Coupons

politicians like the money supply to increase before elections, because a reduction in interest rates stimulates economic activity; consumers borrow more to consume.

gold for cash

All of a sudden, we have a wealth of information on marketing ideas, autoresponders, affiliate programs, list building and so much more. As a result, we tend to lose confidence in ourselves and go into what I call the "freeze mode" or "the cycle glitch."

Rosetta Stone

As inflation mounts, the cure—a sharp reduction in the money supply and concomitant increase in interest rates—becomes more painful. When Paul Volcker, the chairman of the Federal Reserve, pushed short-term interest rates to 20 percent in August 1981 to break an inflation rate that had reached 15 percent, he precipitated a very sharp recession. President Reagan was furious but Volcker stuck to his guns. A politically dependent Federal Reserve probably would not have done so.

Decorative-panel

Wonderful writing and a fascinating story, Matt! I was fearful all might not end well for a moment there but boy was I smiling when that jackrabbit took off!

Verify your Comment

Previewing your Comment

This is only a preview. Your comment has not yet been posted.

Working...
Your comment could not be posted. Error type:
Your comment has been posted. Post another comment

The letters and numbers you entered did not match the image. Please try again.

As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.

Having trouble reading this image? View an alternate.

Working...

Post a comment

Become a Fan

March 2014

Sun Mon Tue Wed Thu Fri Sat
            1
2 3 4 5 6 7 8
9 10 11 12 13 14 15
16 17 18 19 20 21 22
23 24 25 26 27 28 29
30 31