This post The Fed Must Have Inflation. Failure Is Not an Option appeared first on Daily Reckoning.
The Fed says incessantly that “price stability” is part of their dual mandate and they are committed to maintaining the purchasing power of the dollar. But the Fed has a funny definition of price stability.
Common sense says price stability should be zero inflation and zero deflation. A dollar five years from now should have the same purchasing power as a dollar today. Of course, this purchasing power would be “on average,” since some items are always going up or down in price for reasons that have nothing to do with the Fed.
And how you construct the price index matters also. It’s an inexact science, but zero inflation seems like the right target. But the Fed target is 2%, not zero. If that sounds low, it’s not.
Inflation of 2% cuts the purchasing power of a dollar in half in 35 years and in half again in another 35 years. That means in an average lifetime of 70 years, 2% will cause the dollar to 75% of its purchasing power! Just 3% inflation will cut the purchasing power of a dollar by almost 90% in the same average lifetime.
So why does the Fed target 2% inflation instead of zero?
The reason is that if a recession hits, the Fed needs to cut interest rates to get the economy out of the recession. If rates and inflation are already zero, there’s nothing to cut and we could be stuck in recession indefinitely.
That was the situation from 2008–2015. The Fed has gradually been raising rates since then so they can cut them in the next recession.
But there’s a problem.
The Fed can raise rates all they want, but they can’t produce inflation. Inflation depends on consumer psychology. We have not had much consumer price inflation, but we have had huge asset price inflation. The “inflation” is not in consumer prices; it’s in asset prices. The printed money has to go somewhere. Instead of chasing goods, investors have been chasing yield.
In a recent article, Yale scholar Stephen Roach points out that between 2008 and 2017 the combined balance sheets of the central banks of the U.S., Japan and the eurozone expanded by $8.3 trillion, while nominal GDP in those same economies expanded $2.1 trillion.
What happens when you print $8.3 trillion in money and only get $2.1 trillion of growth? What happened to the extra $6.2 trillion of printed money?
The answer is that it went into assets. Stocks, bonds and real estate have all been pumped up by central bank money printing.
The Fed, first under Ben Bernanke and later under Janet Yellen — repeated Alan Greenspan’s blunder from 2005–06.
Greenspan left rates too low for too long and got a monstrous bubble in residential real estate that led the financial world to the brink of total collapse in 2008.
Bernanke and Yellen also left rates too low for too long. They should have started rate and balance sheet normalization in …read more
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