First, the Fed should try to preserve a buffer zone for the inflation rate, that is, during normal times it should not try to push inflation down all the way to zero. As I have mentioned, some observers have concluded that when the central bank's policy rate falls to zero--its practical minimum--monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken.
Indeed, under a fiat that is, paper money system, a government in practice, the central bank in cooperation with other agencies should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.
Like gold, U. But the U. By increasing the number of U. To inflationists, inflation is just obviously coming. To inflation believers, a vast explosion of new liquidity simply cannot be matched with things to buy and therefore must come through into prices rising. Deflation is not an accident in Japan and inflation is not an accident in Venezuela.
Deflation will make the recovery from the coronavirus pandemic harder. Inflation will make it easier. Quantitative tightening has been tried and it failed. QE has been tried and it worked. Deflation makes the situation worse, inflation makes the situation less bad.
How many faster mobile phones will it take to conceal bread going up 10 cents a loaf? Leaving that aside I prefer another argument. It relies on induction. It goes as follows: The market is always right. Therefore the current ridiculous price of stocks must have a reason, based on something in the future more powerful than the biggest dip in GDP since the birth of the industrial revolution at least according to the U.
Could it be that stock prices are going up, not because companies are going to do well but because money is going to nosedive in value?
The market is NOT actually going up in value, the market is preempting the value of money plummeting. The market is simply seeing stocks, underwritten in their solvency forever by their governments, as a hedge against the coming tide of liquidity driven inflation. If the value of money goes up, the prices in money of stocks should go down with the other goods whose prices are depressed. You can have inflation, recession and rising stock prices; you can also have inflation, growth and rising stock prices.
So is the market right or wrong? If the market is wrong, the market will crash, if the market is right we are in for significant inflation. I can scamper really quickly and cheaply between either poles and straddle them both if necessary. In this crazy new world it is important to be able to move between the poles of possibility fast and at low cost because be it inflation or deflation one thing is for sure, its going to be a volatile future.
In recent years, central banks around the world have used extreme measures and innovative tools to combat deflation in their economies. Deflation is defined as a sustained and broad decline in price levels in an economy over a period of time.
Deflation is the opposite of inflation and is different from disinflation , which describes an economy in which the inflation rate is positive but falling. Brief periods of lower prices, as in a disinflationary environment, are not bad for the economy or for consumers. Paying less for some goods and services leaves consumers with more money left over for discretionary expenditures, which should boost the economy. In a period of declining inflation, the central bank is not likely to be " hawkish " in other words, inclined to aggressively raise interest rates on monetary policy, which would also stimulate the economy.
Deflation is different. Deflation occurs when consumers stop spending any more than necessary. As prices fall, they put off buying big-ticket items in the hope that they'll fall further.
The trend continues and builds up speed. Imagine the negative impact if American consumers put off spending on big-ticket items because they think goods may be cheaper next year.
Once consumer spending begins to decelerate, it has a ripple effect on the business sector. Companies begin to defer or slash capital expenditures —spending on property, building, equipment, new projects, and investments. They may begin downsizing their workforces to maintain profitability. This creates a vicious circle, with corporate layoffs imperiling consumer spending, which, in turn, leads to more layoffs and rising unemployment.
Such a contraction in consumer and corporate spending can trigger a recession and, in the worst-case scenario, a full-blown depression. Another hugely negative effect of deflation is its impact on debt. While inflation chips away at the real inflation-adjusted value of debt, deflation adds to the real debt burden. Defaults and bankruptcies by indebted households and companies rise.
Over the past quarter-century, concerns about deflation have spiked after big financial crises such as the Asian crisis of , the "tech wreck" of to , and the Great Recession of to The concerns were intensified by Japan's experience after its asset bubble burst in the early s.
This caused a massive asset bubble as Japanese stocks and urban land prices tripled in the second half of the s. The bubble burst in As deflation became entrenched, the Japanese economy—which had been one of the fastest-growing in the world—slowed dramatically. Real GDP growth averaged only 1. The torrent of cash unleashed by quantitative easing paid off, at least for the stock market. The Great Recession of to sparked fears of a similar period of prolonged deflation in the United States and elsewhere because of the catastrophic collapse in prices of a wide range of assets including stocks, mortgage-backed securities, real estate, and commodities.
The global financial system was also thrown into turmoil by the insolvency of a number of major banks and financial institutions in the United States and Europe, exemplified by the bankruptcy of Lehman Brothers in September There were widespread concerns that scores of banks and financial institutions would fall in a domino effect leading to a collapse of the financial system, a shattering of consumer confidence, and outright deflation. Friedman's point was that putting money directly into consumers' hands was a sure way to stimulate spending.
Although Bernanke did not have to resort to a helicopter drop , the Federal Reserve used some of the same methods outlined in his speech from onwards to combat the worst recession since the s.
The fed funds rate is the Federal Reserve's conventional instrument of monetary policy, but with that rate now at the "zero lower bound"—so-called because nominal interest rates cannot go below zero—the Federal Reserve had to resort to unconventional monetary policies to ease credit conditions and stimulate the economy.
The Federal Reserve turned to two main types of unconventional monetary policy tools: 1 forward policy guidance and 2 large-scale asset purchases, better known as quantitative easing QE. The Federal Reserve introduced explicit forward policy guidance in the August FOMC statement to influence longer-term interest rates and financial market conditions.
The Fed stated that it expected economic conditions to warrant exceptionally low levels for the federal funds rate at least through mid This guidance led to a drop in Treasury yields as investors grew comfortable that the Fed would delay raising rates for the next two years.
The Fed subsequently extended its forward guidance twice in as a tepid recovery caused it to push the horizon for keeping rates low.
But it was quantitative easing that made headlines and became synonymous with the Fed's easy-money policies. QE essentially involves the creation of new money by a central bank to buy securities from the nation's banks and pump liquidity into the economy in order to drive down long-term interest rates.
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