Taylor: Fed Partly to Blame for Global Inflation

John Taylor thinks the Fed needs to tighten policy to reduce the pressure on global inflation:

Easy policy behind global inflation: Taylor, Reuters: Inflation is rising globally because of an easy monetary policy, ... John Taylor said... To tackle rising inflation, Taylor urged the world's policy-makers to talk about adopting a global inflation target.

The creator of the so-called "Taylor rule" of monetary policy, which stipulates that interest rates should rise by more than the increase in inflation..., said U.S. interest rates are now below appropriate levels indicated by the rule.

"During the past year, as global inflation has risen, global short term interest rate targets set by central banks have not increased on average by as much as inflation," Taylor said in a conference on monetary policy hosted by the Bank of Japan.

The average targets have in fact declined since the credit market crisis started in the middle of last year, largely due to sharp rate cuts by the Federal Reserve, said Taylor, now an economics professor at Stanford University.

When interest rates are declining ... in the United States, other central banks have tended to be reluctant to raise rates because that could lead to a sharp appreciation of their own currency, he said.

"Because of concerns about exchange rates and the impact on the exports sector, on the economy in general, central banks are not following the principles that they come to think of as important," Taylor said.

That leads to higher commodity prices, driving inflation all around the globe, he said.

"There is strong evidence that at least part of the increase in energy and commodity prices is related to the global inflationary pressures and thereby, in part, to the policy response to the financial crisis in the United States," he said.

The global dimension of current inflation means a global response is necessary.

"A good place to start is with discussions about some kind of global inflation target," he said, adding that such a target does not need to be a strict numerical target.

I'd like to hear more about what he has in mind for the mechanics of global inflation targeting, i.e. how it would be coordinated across central banks. Credibility of the promises of other members of the coalition in such an arrangement would seem to be one difficult hurdle to overcome (though not the only one), so there would have to be strong penalties for deviating from the global inflation targeting rule. But that would discourage nations from joining in the first place unless they were convinced that the extra restrictions they'd have to follow as part of the coalition would bring them benefits (such as reducing exchange rate changes brought about by a trading partner pursuing a high inflation policy) they couldn't get on their own by strict adherence to a domestic inflation target. [One minor technical point. The article says that the "'Taylor rule' of monetary policy ... stipulates that interest rates should rise by more than the increase in inflation...," but this is usually called the Taylor principle, not the Taylor rule.]

Comments

[euroscot]

A couple of months ago we had a link on the site: 'Gloomy About Globalization (Review of Stiglitz) - NY Review of Books'

The book's reviewer pointed out that since 2000 the dollar has depreciated by 70 percent against a trade-weighted basket of currencies.

However global inflation really kicked off in 1971 when the US scrapped the crucial relationship between the currencies of the world and gold. The international discipline agreed at Bretton Woods post WW2 proved too much.

http://economistsview.typepad.com/economistsview/2008/03/links-for-20-27.html#comments

[hari]

True - Nixon's decision to unlink dollar/gold relationship was historical - and was basis for net incremental expansion in international trade and development.

From a macropolicy perspective I've a lot of problem dealing with global *inflation targetting* without setting framework of policy cooperation, say, Fed/ECB level and/or Treasury.

And one has to consider the place where such a cooperation can have an effective longer term impact across Atlantic. OECD Sec is the right place, from my experience, to focus on such technical work and to give it a bit of professional backup to boot.

Incremental expansion of technical cooperation may eventually convince some of the more critical *experts* that the way forward is well administered and provides reason for joint-policy coordination and some serious hope, etc.

[robertdfeinman]

I'm confused about inflation. If inflation is just an overall change in the price of goods and is accompanied by similar increases in wages then all that changes is the units of measure. It's like switching from feet to meters.

So, that's not what people are worried about when the speak of inflation. What they are worried about is that some sectors of society will be adversely affected and see their wealth decline relative to others. Those who are affected have to have certain characteristics: the have to have some wealth to begin with and they have to have this wealth in a form that is directly related to the value of currency. I claim this is the traditional rentier class.

So inflation isn't "bad". It's bad for those who hold bonds and other instruments which pay at a fixed rate. Once again what seem to be theoretical discussions really boil down to help preserve the asset values of the wealthy.

In times of inflation those who own "stuff" prefer to hold on to it which is why gold, diamonds and art works become popular during inflationary periods. I claim that the current oil situation is partly caused by this effect. Countries can earn more money (eventually) by leaving their oil in the ground and seeing it appreciate. This has caused the tight market.

If there is another reason why inflation is bad, I'd like to hear it. In the 1970's there was enough union power around that earnings tracked price rises reasonably well so workers didn't really suffer. Today this is not true and real inflation may see a further decline in purchasing power, but I don't think this is what is worrying the economists who fret about inflation.

[euroscot]

Indeed, this example of the inability of the US administration to keep to international standards was historical. The decision to delink the currencies in the world from gold was the start of global inflation, the unsustainable expansion of the global economy with credit, and ended up costing many a fortune.

The concept of a league of democracies looks like being historical too. Excluding countries with most of the people in the world and with most of the natural resources seems questionable.

[hari]

*League of Democracies* is a synonym for *racist* imposition of international policy to invade and destroy civilizations which don't truly reflect Ango-Saxon racial purity, me thinks.

Like all previous *crusades* they'll also go to hell!

[a]

"Fed Partly to Blame for Global Inflation"

Dog bites man (partly).

[Winslow R.]

Inflation transfers monetary wealth from savers to borrowers. During this process, poor producers (usually of unskilled labor) with little pricing power, also lose as they are unable to purchase more costly commodities.

Wealthy Savers
Inflation shifts the method of wealth transfer through threat of violence (explicit taxation) to a subtle hidden tax that results in more wringing of hands and less war.

Poor Producers
Poor producers may starve if explicit transfers of commodities are insufficient to provide sustenance. These people then become potential tinder for a violent outburst.

The idea of a world run by an international banking system, is supported by some, including Taylor. Perhaps we are starting to come to grips with the idea that the monetary mechanism is broken?

Until access to banking is democratized, why do they deserve our support? Taylor needs to start at the other end of this inflation and ask why overly concentrated leverage became necessary in the first place.

[paine]

mark surely hits a main barrier
to any de facto
consolidation and concertation
of C- bank policy at the global level
ie
a joint set of national inflation rate targets

why ???
since "self chosen" national best rates prolly
conflict seriously with assigned
best for the whole rates

upshot
each nation
ala the great DEP
may hang separately
cause they can't hang together

the BW dollar gold link
hardly restrained national inflations
they were restrained by fixed rates among currencies
that were anchored to a dollar fixed in gold ounces

but
more to the real nationalist point
the gold peg
kept uncle's
annual trade and payments balance
nearer zero

which inflation rate btw ???

the wage profit spiral driven core rate ???

[paine]

hari
nice morph

caveat :

we ought never confuse
hatred and contempt of
all infidels and aliens
with true blue internal racism
which remains a freak show
a side ally indulgence
unless this
kill or be killed
nuclear option type gig
must get trundled out
by cornered big power corporate elites
gearing up for an uneven cross border scrap
with their rivals
in which case
to carry a big stick
often requires
nationalization
of their ethnic majority wage class

says...

Truth is, every opportunity to prudently and cautiously increase the money supply has resulted in an increase in the prosperity of the nation. Unlinking Dollar from Gold allowed the dollar account to increase in proportion to the willingness of institutional investors to lock up their cash in a basket of Government Bonds that would eventually pay both the cash and new-money interest back on them.

Inflation, as commented above, isn't necessarily evil. It makes mortgages seem cheaper over time (and other long-term debt instruments). It decreases the cost, and increases the value of materials and products held in reserve for manufacturing.

But the Taylor Principle is also key: when one's savings 'inflation' doesn't meet an economy's inflation, the result is that money saved is money lost. According to other articles here, net national (American) savings isn't markedly different from decades ago when both business and personal savings are considered. So, if yields are now below inflation, then the impetus must naturally be a balance between conserving diminishing funds, and spending those funds at a higher rate on products, material, 'hard assests'. Ultimately, assuming that an open market stabilizes prices of things based on supply and demand, the increased demand results in higher prices, supporting the base for inflation. It all ends when disposable money is used up, spending decreases, demand drops, and prices stabilize or drop in turn. The third-order differential calculus of the market inevitably results in boom-bust cycles, where chaotic factors of supply capacity, technological progress, fad, necessity, weather and pests work their confounding force over the S/D field.

Today inflation is mild and increasing, but interest is low and lagging. Stagflation? Yep. That's what it would be. Yet, it is also a period of heightened risk: a country stuck in stagflation's mire for too long runs risks of being permanently devalued in the world amphitheatre of currencies and economics.

GoatGuy

[Spectator]

Inflation almost always impacts the poor worse than the rich. The rich put their money into diverse assets that often do well in inflationary times.

The poor have few investments, and much of their savings is in interest-bearing accounts and real estate. A real estate boom can hide the problem for many, as it did recently. But many of the poor see no benefit even then. The worst impact of inflation is on poor retirees living on savings.

Don't be tempted to think the salaried class will be fine. Inflation steals any potential they have to save and gain financial security. It promotes the sharecropper society that Warren Buffet speaks of.

[hari]

Kissinger is entering the debate on globalization today (IHT). His main argument is that US policy makers are being pushed to protectionism and nationalism in trying to blunt the advance of globalized trading markets with no national boundaries today. US debate is misguided, if I understand him right.

His prescription: Try and narrow the policy divide between business and political parties in order to bridge the gulf for pent-up pressure towards protectionism - impact of which will surely be negative for US.

However he doesn't deal with international targetting of inflation which, as I stated above, cannot be expected to materalize overnight given the current political debate on impact of globalization - including positions already taken-up by political parties and candidates.

It will take a bit of ingenuity to push atlantic cooperation between US/EU and Fed/ECB to find ways and means to move forward within a defined policy framework.

[paine]

spectator
within the property holding class
big may ought perform little
in times of higher inflation
then in times of lower inflation

but the poor and unretired
in this country today
properly defined
have nothing to lose but their jobs
and inflation
is not directly
a job killer

policy moves to squelch inflation
however
usually fight the good fight
by sending net job formation
into the negative range
which takes real wage rates
by the throat and ....

still

with indexed SSI
jobless-ness
is more the enemy of the small
then inflation

and when more or less of either
gets
policy pitted
one against the other

the mostly just a jobster's choice
oughta be obvious

[paine]

goat guy

"Ultimately, assuming that an open market stabilizes prices of things based on supply and demand, the increased demand results in higher prices, supporting the base for inflation"

even if policy faces the absorption of a massive change in relative prices
ie as in the crude pop
by accelerating the rate of price level change
changes in relative prices
per se
imply no necessary increase
in the general price level change

" It all ends when disposable money is used up, spending decreases, demand drops, and prices stabilize or drop in turn."

but why should this necessarily follow ???

"The third-order differential calculus of the market inevitably results in boom-bust cycles, where chaotic factors of supply capacity, technological progress, fad, necessity, weather and pests work their confounding force over the S/D field"

that's a home made instrument your playing
there in the last graph ...eh ??

[Spectator]

You could not argue with the socialist central planners then, and you can't argue with the economy central planners now. They can't seem to recognize how this inflationary policy slowly destroys the capitalist system. Only the total collapse of the system will permit them to see the error of their ways.

This snippet from James K. Galbraith's review of Kevin Phillips "Bad Money" book shows the progressive decay of these inflationary policies.

The prophet of disaster in these matters was Hyman Minsky, a Keynesian strongly focused on financial instability—a fringe topic whose very existence mainstream academic economists blithely deny. A book almost as shocking as this one could be written about the intellectual failure of economists in this field. That failure, even to the present hour, leaves the vast majority of them oblivious, or willfully indifferent, to what’s going on.

Minsky distinguished three steps on the path to doom. The first is “hedging,” when agents expect to service their debts with income. The second is “speculation,” when borrowers enter into debts they know they must later refinance. The third is “Ponzi,” when debts start piling up faster than they can be handled, and collapse becomes inevitable. Minsky saw the 1980s as a transition in the U.S. from a hedge to a speculative position. The Bush era saw the move into Ponzi finance, which we recognize only now, as the scheme unravels.

Inflation is one symptom of the unraveling. Prices of housing, college, health care, food, and fuel have soared. But Phillips calls attention to what is practically a conspiracy, in his view, to keep much of this information from turning up in official data...

[One World Currency]

We don't need 50 different currencies, one for each state. So why do we need hundreds of different currencies to conduct world trade with?

[Inflation]

"Inflation transfers monetary wealth from savers to borrowers."

If a nation has a net negative savings rate, who is the wealth transferred away from then? If borrowers gain from inflation, someone else necessarily must lose.

[Retirees]

"The worst impact of inflation is on poor retirees living on savings."

Social Security is not designed to be enough to live on comfortably all by itself. Due to inflation, the less well to do soon lose their fixed pensions, and bank savings accounts. The less well to do are not generally able to protect themselves from inflation very well, so Social Security is mostly all they have left.

[Winslow R.]

inflation wrote: "If a nation has a net negative savings rate, who is the wealth transferred away from then? "

The U.S. has a net negative savings rate. This means foreign countries are accumulating U.S. reserves. If U.S. reserves can gradually purchase less real assets, those foreign countries lose purchasing power.

inflation wrote: "If borrowers gain from inflation, someone else necessarily must lose."

That would be savers.

[paine]

"Inflation is one symptom of the unraveling"
jamie g.

spec perhaps
you confuse jamie's use of " symptom" with
your use of cause

as in this line :
"this inflationary policy slowly destroys the capitalist system"

a minsky "built in " cyclical hi fi crisis
is not a progressive system destroying catabolism

seems to me
today's big corporate capitalism
with its intricate -- built out of credit ---
hi fi "value pump"
has survived
N self inflicted catarctic moments
and may well survive M more of the same

to me the present hegemonic economic institution
the multi national border free corporate
can not be perminently tamed...
fruitfully domesticate ...
let alone yoked long term
to any public purposes beyond its own

like houdini the limited liability
for private profit trans planet corporation
will always in god's good time
escape the regs and containments
just as it has the first new deal
the treaty of detroit
and
---read closely now ---

the euro social market too

we as progressive liberation dreaming humanists
have to pray to clio
to help us discover
inside ourselves
the makings of a full institutional sublation

[Inflation]

"The U.S. has a net negative savings rate. This means foreign countries are accumulating U.S. reserves. If U.S. reserves can gradually purchase less real assets, those foreign countries lose purchasing power."

All true, but incomplete. A falling dollar versus foreign currencies results in fewer imports, and more exports. That is, fewer total consumer goods/services are available to be consumed by domestic citizens. A lower standard of living.

OPEC can buy less with its foreign dollar reserves, but it charges citizens more for oil. A partial offset for them, and they stop loaning as much money to domestic citizens on top of it. Finding a mortgage or car loan becomes problematical.

Inflating away foreign debt is more complicated than inflating away domestic debt, even with the world's reserve currency. Foreign savers can just take their chips and go home. Foreign govs can and do retaliate, especially if they supply resources essential to our economy. Make them mad enough, and we will no longer have the world's reserve currency.

[Winslow R.]

inflation wrote: "OPEC can buy less with its foreign dollar reserves, but it charges [u.s.]citizens more for oil. A partial offset for them, and they stop loaning as much money to [u.s.]domestic citizens on top of it. Finding a [u.s.] mortgage or car loan becomes problematical."

Lending is not ultimately savings constrained. Access to the lender of last resort is all that is needed.

inflation wrote: "Foreign govs can and do retaliate, especially if they supply resources essential to our economy. Make them mad enough, and we will no longer have the world's reserve currency."

Make them mad enough, then we have a war, losing the reserve currency doesn't necessarily follow. Arab countries have been mad, similar reasons to the 70's oil embargo, just a bit more subtle about it this time around.

[Inflation]

Winslow R..."Lending is not ultimately savings constrained. Access to the lender of last resort is all that is needed."

Monetizing a significant fraction of all domestic debts, public and private, would lead to hyper inflation. The experiment of targeting long term interest rates was given up after the 1970s fiasco. Essentially, only short term debts are now monetized if interest rates leave the target range. Thus, only short term debts are not savings constrained.

Witness the tremendous problems banks are now having trying to unload their mortgage paper via securitized packages. The Fed was able to only take a small fraction of them when foreign savers shunned them. Domestic demand for credit is just too large to extract that much purchasing power from inflation vulnerable entities. Economies have tend to collapse when the experiment was tried in the past.

[Winslow R.]

"Thus, only short term debts are not savings constrained."

This is a policy choice that can be changed.

"Domestic demand for credit is just too large to extract that much purchasing power from inflation vulnerable entities. Economies have tend to collapse when the experiment was tried in the past."

We survived the 70's. There will have to be a resolution to the burden of debt. Bankruptcy of borrowers followed by recapitalization of lenders by government is an option. Not sure it is morally any better than inflation.

[Inflation]

Morally, it would be better to place a surtax on the rich, and use that money to recapitalize banks. Raising an equivalent amount of resources from the inflation vulnerable members of society is highly regressive. Grandmothers living on fixed pensions and bank CDs are in no position to take on this task.

[Inflation]

That is, monetary expansion is a very blunt instrument. It is not suitable for manipulating relative price changes in specific sectors (tech, abodes, hydrocarbons). It is also not capable of extracting resources in an equitable manner.