Posted on 07/22/2010 12:31:35 AM PDT by dajeeps
Our current economic problems started in the second half of 2007 when the rate of inflation started to fall (disinflation), as evidenced by the growth of commodity prices and wages (expectations) outpacing the growth of core inflation, and fell persistently through the end of 2008. This disinflation, which is ultimately controlled by the Federal Reserve, is likely the cause of the housing market collapse. The sharpness of the fall and persistence of it lead to the subsequent banking failures by making loans that otherwise would have been good bad, and turned what otherwise would have been a garden variety recession into a vast chasm of economic stagnation – simply because the demand to hold money increased, yet the quantity of it to be held was falling. It is the same scenario that started and persisted through the Great Depression and I am shocked that it would ever occur again.
The Federal Reserve has relative control over the rate of inflation, when it takes place and by approximates of how much in either direction. Now that the inflation rate has stabilized it is much lower than what is needed to generate growth, and it poses some questions that I believe need to be answered by the Fed Chairman as it appears to be a new stance in monetary policy.
1) Why was the rate of inflation and NGDP allowed to go into a persistent free fall? Did this reflect a change in stance of monetary policy or was it not intended?
2) If the fall in the rate of inflation was intended what is the justification for the ~1% target as compared to the consequences of getting there, verses the trend of 2-3%?
3) If it was not intended, what is being done to restore the 2-3% trend and when will it be done? Who is responsible for it and what is being done to insure it doesn’t happen again?
4) When does the Fed plan on meeting its legislated goal of full employment and how does it plan to do that with a ~1% inflation rate?
Being a creation of Congress, the Federal Reserve is a body of public service and should be required to answer these questions and be held accountable for its actions. Yet whenever the Fed Chairman is called before congress he is handled with kid gloves and is allowed to say that the Fed has other tools in its shed and declines to use them unless economic conditions worsen without challenge.
How much worse do economic conditions have to get before the Fed will act? Does it have to be worse than now or the conditions in 2009 when it was still declining to act? I believe the question should be more related to how much worse do things have to get before our political system turns on the Fed and insists that it do its job.
Maybe governments can’t simply create prosperity out of thin air.
Perhaps debt itself is the problem. Debt is deflationary. Too much debt and the rest of what Japan does for the next 20 years...from 1989 through to today...accomplishes nothing.
Who knows, maybe we’ve seen this show time and again, 1893, 1929, 1989, and today...and still haven’t figured out how to handle it.
Perhaps you are right, but I do not understand why the target rate of ~1% vs. the 2-3% that is considered healthy. Why not zero or negative? How about some serious and unadulterated deflation?
Debt becomes deflationary when the holders of that debt can no longer pay because 1) trend inflation expectations are already baked into the contract and they end up owing more than what they expected to pay and 2) because of the consequences of tightening causes them to lose income. Disinflation and deflation make that a reality. The Fed was created to regulate it, not cause it which it apparently did when it felt that 1% inflation was better than 2 or 3%.
I want to know why. Don’t you?
The Fed has less power to create prosperity and growth than you’ve been led to believe.
It’s a fiction to pacify the masses.
Google “Irving Fisher” and “debt deflation.” There is a paper of hos from 1935 I think you should read to understand the larger picture. One of the first hits Google will give you for Fisher’s paper will be out of the St. Louis Fed.
Then there is a short paper by Hyman Minsky I will try to find a URL to for you. If I cannot find a location for it, I can forward it to you directly.
There is no free lunch. Everything must, and will, one way or another, be paid.,
The Fed was created on a socialist notion and is one of the greatest wealth destroying machines ever invented. It's effects are readily seen in the destruction of physical manufacturing, thousands of once productive great cities, soon to be once great states.
You asked about its employment task. For get about it. Families are the official shock absorber of the state. Errors and costs, and now generational slave debts, are dumped upon them. Sheeple are for shearing.
We have now for two years had the largest borrowing, debts, and so called stimulas since WWII. Only this time we have not built( not that we could anymore) any manufacturing........in the US. It is in China. We have not borrowed from savings( we don't have any) We borrowed from the Chinese. So, so much for multiplier effect, if if there is one. What spending has taken place has been on already employed union government workers( there's a productivity lifting crew!).
Since the government either bailed out its Mini-Me paper money partners, the banks, AIG, GM, etc, or just paid its union 'workers', with the rest of the borrowed money flowing to China, and some to unproductive, price rising boondoggles like solar and wind power, I don't see how we do recover.
Next up, more taxes to service the debt and more spending to keep the lid on domestic/popular anger.
Gotta be careful with Fisher, as he was the celebrity economist who claimed that “stocks have reached a permanently high plateau” days before the Crash of October, 1929.
Anyway, here’s his debt deflation theory:
According to the debt deflation theory, a sequence of effects of the debt bubble bursting occurs:
1.Debt liquidation and distress selling.
2.Contraction of the money supply as bank loans are paid off.
3.A fall in the level of asset prices.
4.A still greater fall in the net worth of businesses, precipitating bankruptcies.
5.A fall in profits.
6.A reduction in output, in trade and in employment.
7.Pessimism and loss of confidence.
8.Hoarding of money.
9.A fall in nominal interest rates and a rise in deflation adjusted interest rates.
What Fisher didn’t note was at what point overall debt accumulation would become so much of a burden that deflation and bubble-bursting becomes inevitable. In other words, how to predict a crisis before it happens.
Fisher did hint, however, that **credit** was as much a part of the money supply as cash.
Fisher seemed at a loss for government debt, though.
Nope. Not me. I think that the Fed is overrated.
Nope. Not me. I think that the Fed is overrated.
Assuming, accordingly, that, at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following chain of consequences in nine links:
Debt liquidation leads to distress selling and to Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation.
This contraction of deposits and of their velocity, precipitated by distress selling, causes
A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
A still greater fall in the net worths of business, precipitating bankruptcies and
A like fall in profits, which in a "capitalistic," that is, a private-profit society, leads the concerns which are running at a loss to make
A reduction in output, in trade and in employment of labor. These losses, bankruptcies and unemployment, lead to pessimism and loss of confidence, which in turn lead to Hoarding and slowing down still more the velocity of circulation.
The above eight changes cause
Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest. —(Fisher 1933)
What I'm talking about is what bursts the "bubble" in the first place. - The Fed - and then it goes down the line. It's disinflation and deflation or tightenging of money. See Milton Friedman's Quantity of Money.
I'm not saying that there weren't problems that need correction. If I recall correctly the inflation rate of 4% for 2007 was too high.
What I want is justification for why it was allowed to go negative and NGDP to fall by 3.8% in the second half of 2008. That is when the Fed should have started stabilizing to the trend rate to keep this spiral from getting out of control, but it did not.
The Fed has more power today. So, for the Fed, the recent events have been good, for it. The economy is more centralized, and centralized out of Washington. This, is good, for the the Fed.
At all times bureaucrats will avoid risk to themselves, and attempt to secure their future existence.
You were asking the Fed to undertake risks to its existence. Not going to happen.
I don’t think the Fed has power to make people rich or create prosperity, but it certainly has the power to make us poor with little hope for the futue and creating a deflationary spiral to get to it’s seemily preferred 1% target is one great way to do it. Sound public policy is only part of having a well functioning economy, sound monetary policy is the other.
I’m surprised that more people aren’t asking why it allowed inflation to go negative and NGDP to fall by 3.8% in August of 2008 instead of stabilizing to the trend, which it certianly could have done but chose not to.
The missing part you mention is addressed by Minsky. Minsky addressed two issues that Fisher ignored: when the “tower of debt” becomes unstable, and the interconnectedness of the “web of debt” causes cascading failures that are very difficult to predict where the web will start to unravel.
You’re right that Fisher was a doofus on stock valuations. He was like the fools who liked to talk of “the New Economy” in 1999. Every generation has its gullible fools. Fisher walked his talk and subsequently paid for it.
The sequence of events you summarized is what I want people to see. We can see many, if not most of the issues arising in our economy now.
The “credit as money” is also important for people to understand why reduced lending by banks is deflationary, even as the Fed is pumping money into the banking system with wild abandon. As Fisher notes, one of the symptoms is cash hoarding, and bankers are doing that in spades.
The other issue brought forward by Fisher is the “real interest rate,” where inflation expectations are factored in. That is part of what I wanted people to see WRT the original post.
I’ve sent many letters and emails to my representatives and what I’ve found is on the email side or contact info on their web pages, all their support staff looks at is the subject line and the send out the canned response and never read or replay to actual content. From the letters I’ve received back from an actual letter sent it’s pretty much the same thing unless you’re requesting help and then you’ll get an answer specific to that.
My guess, someone will scan this and see recession, unemployment and you’ll get the canned response.
Be interesting to see what they actually answer with unless of course they are voted out before they respond.
My personal opinion is that we have been there for over a year yet none of the consequences Fisher claims will happen have happened. In fact, the market has grown. What are people investing in? Why haven't we devolved into the state he describes?
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