Deflation? Quantitative Easing?

Does today's news that the CPI fell 1% last month mean we headed for deflation? Not if the Fed has anything to say about it:

Fed’s Kohn: Deflation Risk Bigger but Still Small, by Brian Blackstone, RTE: Federal Reserve Vice Chairman Donald Kohn said Wednesday the risk of deflation in the U.S. is bigger than a few months ago, but “still small.” He also said monetary policy should respond as aggressively as possible to any deflation possibility, suggesting additional interest rate cuts remain on the table.

Kohn’s remarks come on the heels of a government report showing that consumer prices fell by 1% last month, the sharpest plunge in 61 years.

Responding to questions following a speech..., Kohn said, “in terms of the risk of deflation, there is a risk out there but it’s still small in my mind.” The likeliest scenario, Kohn said, is a “couple of quarters” of negative gross domestic product and “inflation coming down” without getting into a deflationary state.

Though Kohn noted that while “some have argued that we should save our ammunition” on interest rates, he thinks that “were we to see this [deflation] possibility…we should be very aggressive with our monetary policy, as aggressive as we can be.” Indeed, Kohn said the lesson from Japan’s experience with deflation is “not to let that get ahead of us.” ...

Meanwhile, Kohn added that the Fed has “already” engaged in forms of quantitative easing, and “we should be looking carefully” at the effect that could have “as a contingency plan should that still-remote possibility, but I think less remote than it was, occur.” ... He said the Fed hasn’t abandoned monetary policy in favor of quantitative easing, noting the Fed’s recent reduction in its target federal funds rate. “I don’t think we’ve given up on one in favor of the other,” Kohn said. He also said there’s no “arithmetic” reason why the Fed can’t “blow up” the size of its balance sheet, which has already swelled in recent weeks to over $2 trillion.

William Poole says he thinks there has been an unannounced change in policy, and he questions whether that is legal:

Has the Fed changed its policy unannounced? Poole says yes., Rebecca Wilder: The effective federal funds rate has deviated miles away from its Federal Open Market Committee (FOMC)-set target over the last couple of months. I, along with really smart economists like James Hamilton, have fought to explain this phenomenon. But perhaps it cannot be explained because we don’t have all of the information!

A bit from Bloomberg (hat tip reader Stephen Saines):

The Federal Reserve's efforts to rescue the U.S. from financial collapse risks the eclipse of the central bank's benchmark interest rate as the most important signal of monetary policy.

Record injections of liquidity have driven the overnight lending rate between banks to less than half the 1 percent target set by officials last month. The gap is shifting investors' focus toward the amount of money in the banking system as a better gauge of Fed intentions, something San Francisco Fed President Janet Yellen last month called ''a kind of quantitative easing.''

Has the Fed moved toward a money growth target, rather than an interest rate target? William Poole – former President of the Federal Reserve Bank of St. Louis – accuses the Fed of not being transparent and shifting monetary policy without announcement. Although he does not speculate as to what the new policy is, he does state that by not announcing its new policy, the Fed is breaking the law.

According to Poole: “Something is happening at the Fed that has not been announced.” [Watch the video here (hat tip reader Paul Cox).]

I will wait for the announcement because frankly I am confused.

Comments

[Bruce Wilder]

"consumer prices fell by 1% last month"

That, of course, would "be" deflation, not a risk of deflation, or “inflation coming down”, but the beast, itself. Given the massive de-leveraging, offset though it may have been by increases in liquidity, deflation is an expected result. duh. And, without a massive fiscal stimulus, it is going to be impossible to stop. Can the Fed leverage the mere expectation of a February stimulus, to create a bridge over the deflationary gap? I have my doubts.

[halbhh]

There is some point, perhaps impossible to pinpoint except in a postmortem months later, where a beneficial correction/adjustment in prices after a credit driven bubble in prices, is no longer a correction, but something more.

We aren't there yet I think, but.....it's impossible to say actually. That boundary could be nearby, or months away.

The only sensible idea I've heard or thought of is to stand ready to rapidly pass a giant stimlus package which needs to include the instant effect of people knowing another "rebate" is coming as soon as the IRS and print the checks.

That's what can stop a deflationary spiral psychology of too much consumer fear of spending.

[halbhh]

Infrastructure spending, though wise and good, will *not* stop a deflationary spiral.

[Anon]

Ah, when the CPI spikes, it's just a temporary phenomenon - nothing to see here. But when it declines, quick - let's do something.

Also, how much mention do you see that ex-energy/food (anyone remember core?) inflation is still very much with us.

The cumulative level of inflation since the Fed's creation has been very high. Since the 1930s even more so. I get the impression that talk of deflation, now and a few years ago, is nothing more than cover for inflating.

How perpetuating unproductive, even counter-productive imbalances helps us is beyond me. This inflation/deflation scam has been going on for so long that I wonder if it has become a permanent feature of our society. I take comfort from the fact that highly destructive large scale wars also used to be the norm and they seem to have gone out of favor. Maybe it's possible that we, as a society will wise up to this sophisticated form of robbery, but I see no signs so far. Sigh.

[Bruce Wilder]

What are you blubbering about, anon? Do you even know?

Of course, the managers of a fiat currency aim for a low, steady rate of inflation. It took 300 years to figure out that a low, steady rate of inflation was the best choice, but I think we have that lesson learned. Are you suggesting we unlearn it? Do you feel a personal need to experiment, to re-learn just how economically catastrophic deflation is? Are you laboring under the delusion that deflation can be a good thing?

[ccm]

I looked up TIPS yields today. They are clearly pricing in deflation in 2009. (Inverted yield structure with highest yields on 2010/2011 maturities. Remember these yields are real -- the nominal yield will fall, if the reference price index falls.) Now I believe that the inflation rate used to calculate TIPS is below the Fed's reference rate, but TIPS markets imply that Fed policy will do no more than keep the inflation rate at zero.

[bakho]

For once, I would like to see the Fed throw up its hands and say, "Look. We've reached the end of the road with monetary stimulus. Nothing else the Fed can do would possibly make as much difference as fiscal stimulus?

We have created a system where monetary policy can be set by functionaries immune from the political process, but fiscal policy is divorced from monetary policy. This schizophrenic system impedes an integrated approach to economic policy, unless those in charge of fiscal policy are willing to work in concert with monetary policy and those in charge of monetary policy do not abuse their power to extort fiscal policy concessions. Maybe monetary worked so much better because of the sane fiscal policy of the 90s and has sputtered because of the fiscal insanity that is the Bush policy?

[anon]

Mr. Wilder - First, I appreciate your politeness as much as I do sarcasm.

All inflation does is create imbalances in the economy by giving out unearned money via the banking system (who unsurprisingly are the ones to profit most from it.) When that rate is sufficiently low, we'll merely have mild to moderate recessions from time to time.

I agree with you that the authorities have discovered that low inflation makes it possible for them to retain their franchise. Of course, that hasn't stopped them from letting loose when they found it convenient to do so, as in the 1920s, 1970s, 1990s and 2000s, to cite a few of the larger bubbles they at least accommodated if not created outright.

While sudden unexpected deflation is indeed destructive, as even Thomas Jefferson observed some 200 years ago, such deflation is preceded and brought about by inflation. Low to moderate deflation can indeed be a byproduct of prosperity, as it denotes production rising faster than the medium of exchange.

This is a long standing debate which we won't resolve in brief comments. I commend to you the site "mises.org" for many freely available articles and books (free in electronic form) for the unconventional and hopefully mind-expanding view.

Also, look up "The Creature From Jekyll Island" by Edward Griffin about the process by which the large bankers brought about the creation of the Fed for their own interests while making it seem like it will control them. There are also brief videos freely available online summarizing his views.

[hari]

I don't understand monetary policy to explain MTs observation. However if deflation is (already) factored-in what can monetary policy do under the circumstances? Does it have any traction?

This situation reminds me of Japan - Anne has been taking a lot about the mistakes made by JCB - duration of their inability to change policy was incredibly long.

Paul Krugman has also studied Japanese deflation and causes of it.

Why is Pool demanding BB/Fed to speak up, if policy has changed? Or are we in uncharted waters?

[Jrossi]

Re; TIPs. As I type this, the yield on the 10-year TIPs is 2.93% real and the yield on the 10-year treasury is 3.38% nominal. Today's news notwithstanding, who the hell believes annual inflation will be about 0.5% over the next decade? Efficient markets my foot.

[OhNoNotAgain]

My God, if I hear one more recommendation to go read mises.org, I'm going to scream. Is this some sort of cult that I missed out on ?

"Low to moderate deflation can indeed be a byproduct of prosperity, as it denotes production rising faster than the medium of exchange."

Yes, but that is the type of deflation whereby the companies lowering the prices are still making the same, or better, profit margins. When the cost of creating something goes down due to productivity increases, or the fact that product sales have reached a volume that represents an economy of scale, then the price can go down without any change in the overall profit. What we are seeing here is not that "good" deflation, which is usually specific to certain growth sectors like technology, but rather the bad kind of deflation where you have prices going down as part of an effort at keeping sales revenue from falling further. The basic question is this: are the companies that are lowering prices seeing their sales volume go up or down ? If it's down, then we're experiencing the bad deflation (which we are). Pretty soon that leads to massive layoffs (already started) and the shuttering of production facilities.

[ECONOMISTA NON GRATA]

".....Not if the Fed has anything to say about it:....."

The Fed can "say" whatever it wants, they can talk themselves silly. The question is, what can they "do"...?

The answer is, very little.

It's too late to act and too late to fight.

Best regards,

Econolicious

[elpresidente]

CPI drops are NOT deflation.

Deflation would occur if there is a drop in the GDP deflator, not some random basket of goods and services people consume.

[anon]

OhNoNotAgain - when one is steeped in orthodoxy any dissenting view appears to be representing a cult. I simply offer an alternative view. I'm puzzled that evokes such strong reactions.

Re. the "bad" deflation you mention, I agree with you. I also note that as far as I can tell, it is always preceded by a bubble of some sort. While there are many that argue that the causes of bubbles are not well understood and have more to do with mass psychology, the same Mises you seem to dismiss, explained the dynamic 100 years ago. His explanations fit every one of the bubbles that has come since. In a nutshell, regardless of psychology, without enough money floating around, you can't have much of a bubble for more than a brief period. The people in a position to make available the huge amounts of money required, are banks and other financial institutions lending money they don't have via fractional reserves (while typically increasing their leverage ration) and/or central banks.

This is why Jefferson wrote:

"If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered."

It is also why Lord Acton, the Chief Justice Of England wrote in 1875:

"The issue that has swept down the centuries, and must be fought sooner or later , is, The People vs. The Banks".

You can dismiss this as some cult's views, or you can open your mind to alternative thinking and explore it seriously. Regardless of the view you ultimately form, I think your thinking would end up more sound with such an approach. Of course, that's just my opinion.

[jalrin]

The government has the power to stop deflation if need be. All that is required is a monetization of a large enough percentage of the national debt to break the deflation spiral (including whatever is created to finance a large fiscal stimulus package).

[kthomas]

I'd like to see some of our wastelines deflate. America has been getting FAT. Look at all the new Diabetes cases. I read that California alone spends over 200$bil a year treating this disease.

[Patrick]

anon: not all dissenting points of view are equally valid.

Mises and Hayek argue that prices convey all information and that therefore the only rational way to allocate resources is through unfettered capitalism.

The problem is that information asymmetries abound. Thanks to Stiglitz (who won a Nobel Prize for the work), we can be pretty confident that there is always a policy intervention that will result in a Pareto improvement.

Even if you don't concede the first point, just look at the evidence before you: essentially unregulated lending practices coupled with perverse incentives led to the creation of opaque, exotic derivatives that just blew-up in our faces. Sure, cheap money was the trigger, but ask yourself this: Why wasn't it equally likely for cheap money to be spent on productivity enhancing capital as it was on unproductive housing stock and financial engineering? After all productivity enhancing capital becomes no less attractive in an easy money environment. The answer is: irrational actors.

To paraphrase Keynes: how do you expect irrational actors to act irrationally and arrive at a rational and just outcome?

[Friedrich von Blowhard]

Dear Patrick:

You write:

Why wasn't it equally likely for cheap money to be spent on productivity enhancing capital as it was on unproductive housing stock and financial engineering?

I can think of two possible reasons.

First, the U.S. government through military R&D gave us an incredible string of productivity-enhancing new technologies: jet airplane travel, computers, advanced electronics (of all types), fiber-optic communications, the Internet, atomic power, etc., etc. This string of advances seems to have petered out in the 1980s. I suspect if we had continued to have more of this type of innovation, we'd have had more real world innovation and less financial "innovation" (all of which turns out to be increased leverage in one form or another) in the past decade.

Second, as Hellasious at Sudden Debt points out, very cheap capital keeps creative destruction from happening, as businesses can earn "good enough" returns from status-quo, non-innovative projects. I wonder if the existence of cheap debt, in itself, has actually retarded innovation and productive investment in this country.

So much for the (not so) Great Moderation the Fed was breaking its arm patting itself on the back over.

[RueTheDay]

While I always find Austrian ideologues amusing, there's something missing in this discussion on deflation. The missing ingredient is debt. In the absence of high levels of debt, deflation can be good or bad as other posters have noted. In the presence of high levels of debt, deflation is always and everywhere toxic. Irving Fisher explained the process 70 years ago in his Debt Deflation Theory of Great Depressions, (and Hyman Minsky further refined it) thusly:

"(1) Debt liquidation leads to distress selling and to
(2) 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
(3) 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
(4) A still greater fall in the net worths of business, precipitating bankruptcies and
(5) 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
(6) A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to
(7) Pessimism and loss of confidence, which in turn lead to
(8) Hoarding and slowing down still more the velocity of circulation. The above eight changes cause
(9) 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.”

Others have summed it up as "the more debtors pay the more they owe" referring to the positive feedback loop that is created as consumers cut back consumption and firms cut back production in order to service their debt which results in further deflation which increases the REAL burden of their debt, causing them to further cut back on spending, and so on.

[anon]

Patrick,

Thanks for the thoughtful response.

I agree with your points on "unfettered capitalism" and regulation. For purposes of this discussion, I'm limiting my focus to the issue of the banking system.

You can have essentially the same system we have now, but with a sound banking system and currency. I think Mises and Murray Rothbard shine in their analysis of banking and money, independent of the other issues they raise.

I don't see how you can have sound banking and money if private organizations and/or the government are allowed to create money out of thin air whenever and however much they want to. While in theory they could restrain themselves, in practice they have only done so for limited periods of time and when they let loose, the results are devastating, as we are witnessing.

Regarding your point about the evidence, all of the bad behavior wouldn't have been possible without all of that cheap and easy money - at least not to a great extent or an extended period. Easy money will always search out the fastest returns, especially when they think they're being backstopped (as it turns out most of them were.) It takes much greater effort and time to find and make productive investments, so it's no surprise that while we probably did get some of that, most of the easy money chased the bubble.

I made reference to mises.org because there are a lot of good articles and audio interviews addressing exactly these issues in a straightforward and lucid manner. One doesn't have to subscribe to everything they advocate there in order to see the wisdom of some of it, especially in regard to sound money and banking.

[RueTheDay]

Anon - Gold standards and wildcat banking do not constitute "sound money and banking systems". We have tried both, and both failed miserably.

[anon]

RueTheDay:

I don't believe we've ever had sound money and banking, at least in the modern era. Kings always ended up debasing the currency and so have democratically elected governments. As for the gold standard, the government could and did set the rate of exchange to paper money (most famously in the 1930s) so it was a gold standard in name only.

Plus, even with a gold standard if banks are allowed to create money out of thin air, gold is all but irrelevant. While inflammatory, I do think it's fair to describe the process of lending money you don't have as akin to fraud. It's essentially a variant of a Ponzi Scheme. I don't see how government blessing changes the underlying substance - it's just a veneer of respectability.

I am always amused by those who express shock and amazement when the bubbles blown via easy money burst when I think it takes magical thinking of a sort to believe they won't. As Lord Acton said, this is an age old problem.

FWIW, I think it will only be resolved the hard way - when the current system crashes of its own weight. It's impossible to predict when that will be just as it's impossible to predict when a bubble burst, but statistically it is all but certain that it will. I hope I'm not around when it does - it won't be fun (not that what we're going through now is all that enjoyable.)

[Ben]

“not to let that get ahead of us.”

Too late. The Fed is throwing money at anyone they can to get it circulating. The trouble, obviously, isn't liquidity but solvency - as has been said a thousand times. Is there a bank in the US that is solvent? Certainly none with readily recognizable names are.

[groucho]

"Do you feel a personal need to experiment, to re-learn just how economically catastrophic deflation is? Are you laboring under the delusion that deflation can be a good thing?"

BW, Ugh, YESSSSSSSSSSS, except the catastrophic part. The only catastrophic situation in deflation, especially this latest merry-go-round of record debt load is on the hi-fi and govt side.

Deflation by definition means increased purchasing power hence rising standard of living for those whom produce and exchange real value. The losers are those that produce nothing of value(banking & much of govt).

Hence the extreme determination of finance(and govt) to "make sure deflation doesn't happen here" which results in loss of banking power.

Which is why Amschel Mayer Rothschild who in 1838 said: "Permit me to issue and control the money of a nation, and I care not who makes its laws."

An argument has been made that DEBT deflation is crippling, but the current bout of "walking away", debt renegotiating, bankruptcy, etc make that fallacy silly.

Let us hope that deflation(rising standard of living for working citizens) becomes the norm in the world or the world we inhabit will be one of war...the true war to end all wars.

[Beezer]

Anon:
"all of the bad behavior wouldn't have been possible without all of that cheap and easy money - at least not to a great extent or an extended period. Easy money will always search out the fastest returns, especially when they think they're being backstopped (as it turns out most of them were.) It takes much greater effort and time to find and make productive investments, so it's no surprise that while we probably did get some of that, most of the easy money chased the bubble."

I believe this is a central truth behind many observations that have been made about this recession and the Great Depression. Income disparities arrived as a result of increasing wealth without the need of new productive investments. Labor did not benefit once the main productive investments were made. This wealth chased paper assets, in lieu of productive ones. But productive investments aren't a given, are they? Might we have periods of stagnation, where new inventions cannot keep the money created invested?

We've been in a 150 year period of fantastic innovation and invention. May there be a pause? Might there have been small pauses where wealth, in truth, had too few productive outlets in which to invest. Might these pauses, without informed monetary restrictions on money growth, create investment excesses--bubbles?

To me, there is sense in these observations. However, none of this points to what is needed right now, in bootstrapping a world economy that is so interrelated.

I don't think anyone has figured out the underlying truths quite yet. But right now it is obvious that productive investment is needed badly. And there doesn't appear to be any lack of obvious areas such investments need to be made now--badly.

Many deal with the need for energy reformation. Others deal with the high risk-high reward investment in R&D. Fast money growth, low money growth, it doesn't matter much at the moment. What we need now is swift action. An enabling government.

Silver lining. We don't have to make these investments in order to fight a global war. At least not yet. Beware. When America turns inward, it's adversaries are emboldened.
God Bless Obama. May his path, and ours, be blessed.

[Too Much Fed]

See this quote from itulip.com:

"Quantity versus the price of money

The reason they are targeting aggregates is that as deflationary forces intensify with debt defaults, tightening lending standards, and a shrinking pool of credit-worthy borrowers, rate targeting (the price of money) becomes less effective as a policy tool to manage inflation. Targeting money aggregates (the quantity of money) becomes a more effective tool.

It’s the flip side of the problem that the Fed had in the late 1970s when inflation was very high. The Fed switched to targeting quantity over price then, between 1979 to 1982, because money price targeting is ineffective at the extremes of high and low inflation."

Link:

http://www.itulip.com/forums/showthread.php?p=48133

Mr. Janszen was wrong about the fed not cutting rates probably because LIBOR increased and the fed was worried about ARM's resetting.

[OhNoNotAgain]

"OhNoNotAgain - when one is steeped in orthodoxy any dissenting view appears to be representing a cult. I simply offer an alternative view. I'm puzzled that evokes such strong reactions."

It evokes a strong reaction in me because it reeks of ideology, i.e. the need to blantantly forget why we have arrived at this point in our economic history. While I can certainly agree with you that easy money was a big cause of where we're at today, that is not indictment of the system that we have, but rather an indictment of those that were managing the Fed/system at the time. We have, after all, human beings running our system, and when they make ideological decisions that are not based upon sound evidence, then we will have problems. This idea that Greenspan espoused about not being able to take away the punch bowl when the party had clearly gotten out of hand, and for the second time in a decade, was clearly a huge mistake. We should never err on the side of allowing bubbles to get out of hand, especially when they are being caused by vague and un-regulated financial instruments. We don't need a new system, we need better economic leaders that understand that stability is the goal, not a casino-style economy.

[calmo]

Thank you Beezer for your thoughts...starting here [with my responses like so ]I believe this is a central truth [well, at least you don't capitalize "truth", I am so much less religious.] behind many observations that have been made about this recession and the Great Depression. Income disparities arrived [no need to make a statement about the trends in those disparities? I wonder if there is a huge difference esp from the 80s on that needs to be differentiated?] as a result of increasing wealth [yes, but even faster increases in wealth disparities, and it is becoming clear to even me now, increases in wealth volatility because of this paper (financial) connection ] without the need of new productive investments. Labor did not benefit [do you take an explicitly Marxian view of profit or should we just skipit?] once the main productive investments were made.
...
To me, there is sense in these observations.
Ok, but some blinkers maybe too. I'm missing your view of the other side: the consumption from which the profits and ultimately the wealth are generated. The wider cast of that consumption net and the longer cast into the future with so many of the new "financial instruments".
The expiration of the US consumer...not an accident and not an isolated incident from which we can pick up the ball tomorrow when the emerging economies consumer blossoms.
Is that too ideological?

[anon]

OhNoNotAgain - I see where you're coming from. I have also viewed the knee-jerk defense of the current system as "reeking of ideology." Still I appreciate a thoughtful exchange of ideas.

I agree that it was the gross mismanagement, whether ideologically driven or not, that led to our current and prior messes. I'm simply suggesting that the system by its very nature invites such abuse. Those with authority to create money for/from nothing will always find an excuse for doing so. Power tends to corrupt. I think we have seen this quite clearly these past 8 years as well as throughout history.

I can't see a good defense for the equivalent of counterfeiting. There is a good reason it is not tolerated. When done illegally, it is considered fraud and/or theft, because someone who does it is exchanging something of value for nothing. When the government legalizes it for itself and gives license to banks to do it, it is by definition not illegal, but it has exactly the same effect.

Imagine what would happen to our civil liberties without the Bill Of Rights. Imagine what would happen if the IRS had authority to seize any amount of money from anyone at any time, with the only restraint being its own discretion. Well, the Fed has such authority now via creating and/or authorizing banks to create any amount of money arbitrarily at any time. Is it any surprise that it has used it? While some may argue it was for public benefit, I think the evidence is clear it is for the benefit of well connected private interests. The same ones that brought about the creation of the Fed in the first place.

Until we place solid constitutional restraints on the willy-nilly creation of money and, as a society, become better educated about what our governing elites are doing to us, I believe we're bound to repeatedly go through the type of crisis we're going through now if not much worse. I do sincerely hope to be proven wrong by events, but it's not looking too good at the moment.

[Bruce Wilder]

The Austrians confuse the tropes of good storytelling for mechanisms of the macro-economy. It is sort of pointless to argue with them. It is like arguing with Homer about the deeper purposes of rosy-fingered dawn; the sun will still rise, regardless of how the blind poet describes it, and we will see it, and he will not.

Every indicator before us adds reason for profound pessimism.

[Too Much Fed]

I'm going to do poole one better.

Has the fed misused the mandates of low (price) inflation, moderate interest rates, and full employment to MAXIMIZE DEBT and give most people NEGATIVE REAL EARNINGS GROWTH and then used that debt to allow real GDP, housing prices, and stock prices to grow FASTER than they should have???

Notice the mandates say NOTHING about wage levels, positive real earnings growth, debt levels, budget defictis, or trade deficits.

Did greenspan have ANYTHING to do with the law that gave the fed this power???

[Deficit Hawk]

from Beezer: "Labor did not benefit once the main productive investments were made. This wealth chased paper assets, in lieu of productive ones." Too bad Greenspan didn't figure that the big income disparity and lack of wage increases for labor indicated a bubble and excessive expansion of leverage-supported financial instruments.

Productivity increase while wages lose may be a good indicator of the next bubble or other major financial problem that could be pro-actively examined and corrected. Might mean no more experiences like the current and the 30's economies.

[Lafayette]

Silver Lining

I say we should get used to a 1% decrease in the CPI as well as a likely 1% decrease in GDP. Which is one helluva lot better than a 1% decrease in GDP combined with a 1% increase in the CPI!

The Silver Lining: Deflation opens purses as discretionary income goes further, prompting people to spend, expanding Demand, supporting jobs -- priority Numero Uno for any economy with cojones.

Let's face it, nothing can go right with this economy for at least another year, whilst it mends itself.

In the meantime, let's get off the blog, go out and buy something. Anything.

Positivate -- negativism only begets more negativism in a deadly spiral.

[Too Much Fed]

Deficit Hawk said: "Too bad Greenspan didn't figure that the big income disparity and lack of wage increases for labor indicated a bubble and excessive expansion of leverage-supported financial instruments."

I believe that greenspan was DUMB ENOUGH to believe that this is the best way for an economy to be.

[anon]

Mr Wilder - you're the proverbial pot calling the kettle black. Even if I wanted to argue, you offer nothing of substance to argue against. You simply dismiss that with which you disagree. I don't see how that contributes to increasing our knowledge and understanding. To each his own.

[Too Much Fed]

Lafayette, I believe that the fed will do EVERYTHING AND ANYTHING to prevent price deflation and POSITIVE real earnings growth for most people because either one can lead to LESS DEBT (which would mean the bankers and the rich become less powerful and not as rich)!!!

In my opinion, they will TANK the dollar and/or want to bankrupt the gov't thru a BIG deficit if necessary!!!

[Too Much Fed]

Oops! There is ONE THING the fed will NOT do. Print actual currency (dollars) and allow a WAGE BUBBLE!

[Too Much Fed]

OhNoNotAgain said: "We don't need a new system, we need better economic leaders that understand that stability is the goal, not a casino-style economy."

If stability is the goal, then how about MINIMIZE DEBT, keep goods prices from rising too fast, keep asset prices from rising too fast, and ELIMINATE EXTREME income inequality???

[calmo]

Hi Too Much Fed [it B me, calmo Too Little] I believe that the fed will do EVERYTHING AND ANYTHING to prevent price deflation [absolutely agree, but note some failures: housing and autos...possibly spreading further...until we regain our composure] and POSITIVE real earnings growth for most people [you mean workers have less disposable income designed in house --by the fed ]because either one can lead to LESS DEBT (which would mean the bankers and the rich become less powerful and not as rich)!!![Such a novel approach: debt as the center piece of the economic system, cunningly crafted by the fed, representing those nasty bankers...the only beneficiaries. Does it have any explanatory power? What happened recently? Can you predict what will happen in a month's time? Or izit still a work in progress? Or are you merely bloviating? I can BLOVIATE too. See?

[Fred]

Arguing with Austrians is hopeless. It is indeed a cult. All you can do is attempt to understand the motives. They universally grew up in authoritarian, patriarchal environments where the emphasis was on unity rather than diversity. There is ONE truth, not multiple truths. In particular, there can be no such thing as a truth for the individual which conflicts with the truth for society. Moral relativism is out, in other words. If taxes are bad for the individual, then taxes must be bad for society, or vice-versa. If savings is good for the individual, then it must be good for society, or vice-versa. Note how the Austrian emphasizes the individual in the above two formulations, whereas the Communist emphasizes society. In both cases, there is an authoritarian mentality at work. The Austrian and Communist are mirror images of one another, alike unable to conceive that understanding reality requires taking multiple points of view.

The rigidity of the Austrian/Communist mind typical leads to poor performance as players in the world of economic reality. They are lousy investors, lousy entrepreneurs, lousy at everthing but the most narrow minded technical sorts of jobs. Many of them end up as government bureaucrats, I've noticed. When a narrow-minded person has the means and desire to save, then they typically end up investing in government bonds, and hence there is a financial incentive to want deflation--Austrian economics beckons. When a narrow-minded person is unable or unwilling to save, then they end up broke--Communism beckons, since he who is broke has nothing to lose from redistribution and everything to gain. Austrians and Communists always have an intuitive understanding of the opposing ideology, which reflects the similar underlying psychological basis.

I am not surprised that so many people are attracted to Austrian and Communist economics, just as I am not surprised that most people can't begin to understand Einstein, even though the special theory is quite simple. Keeping multiple points of view in the head at once is hard. Which incidentally is why conscious hypocrisy is so rare. Rather than believing one thing but saying something else, it is much easier to just change your beliefs to match what you say. Which is also why it is generally hopeless to try to change a narrow-minded persons's mind. If there is only room for one belief in their head at once, then they only way to get a new idea in is to first completely remove the old idea, and this is quite difficult.

[anon]

Fred - while you may be much more well-adjusted and more sophisticated in your thinking than I am, I noticed you specialize mostly in put-downs. I prefer to seek a better understanding of the world around me. If you have any ideas on the topic at hand, I have yet to notice. Like I said, to each his own.

[Juan]

Well heck, I was hoping someone might consider price change to be but one of the phenomena associated with different phases of the business cycle, particularly changes in rate of nonfinancial profit. At least 140 yrs ago we knew that declines in that rate tended to provoke greater speculative activities and expansion of fictitious capital which, not recieving institutional support, was largely destroyed within the overproduction crises proper.

[groucho]

Did Hayek and Robbins deepen the Great Depression?(Friedrich A. Hayek)(Lionel Robbins)

Publication: Journal of Money, Credit & Banking

Publication Date: 01-JUN-08
Author: White, Lawrence H.

"In reply to Parker's question of whether the Austrians wanted to "purge the rottenness" from the system, however, Friedman (Parker 2002, p. 43) remarked, "Well, I don't think Hayek or Lionel Robbins would have used that phrase. They would have said you simply have to use up the excessive long-lived goods and get back to an appropriate relation between capital goods and consumer goods."

DeLong's thesis that the Hoover administration and the Federal Reserve were following Austrian advice thus coincides with Friedman's judgment that the Austrian advice did harm. Both suggest that "do-nothing" policy prescriptions by Hayek and Robbins contributed to deepening the Great Depression in the United States. But is this an accurate account of Hayek's and Robbins' actual monetary and fiscal policy advice during the early years of the Great Depression? Is it an accurate account of the policies of the Hoover administration, of the Federal Reserve System, and of what influenced them? A critical examination finds DeLong's history unpersuasive on four key points.

(i) The Hayek-Robbins ("Austrian") theory of the business cycle did not in fact prescribe a monetary policy of "liquidationism" in the sense of doing nothing to prevent a sharp deflation. Hayek and Robbins did question the wisdom of reinflating the price level after it had fallen from what they regarded as an unsustainable level (given a fixed gold parity) to a sustainable level. They did denounce, as counterproductive, attempts to bring prosperity through cheap credit. But such warnings against what they regarded as monetary overexpansion did not imply indifference to severe income contraction driven by a shrinking money stock and falling velocity. Hayek's theory viewed the recession as an unavoidable period of allocative corrections, following an unsustainable boom period driven by credit expansion and characterized by distorted relative prices. General price and income deflation driven by monetary contraction was neither necessary nor desirable for those corrections. Hayek's monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction. The germ of truth in Friedman's and DeLong's indictments, however, is that Hayek and Robbins themselves failed to push this prescription in the early 1930s when it mattered most."

[Bruce Wilder]

elprez, if you don't think the recent CPI indicated deflation ... Well the corporate bond market disagrees. See Krugman for a chart, reproduced by Mankiw

Sorry, anon, I don't feel like going down the Austrian rabbithole

[Lafayette]

TMF: In my opinion, they will TANK the dollar and/or want to bankrupt the gov't thru a BIG deficit if necessary!!!

Your comment cited above therefore insinuates that the Fed will willingly commit malfeasance (negligence of official responsibility).

Frankly, that's preposterous. They make mistakes, yes, low-cost money being the latest. But they are not so stupid as to undermine the dollar.

Some facts, please. Spare us the emotive exclamation points.

[anon]

When I suggest that sound money and banking would be better than our current (bankrupt?) system, there are those that stick a label on it so they can summarily dismiss it. They then claim that their analysis is superior. While they do not specify said superior analysis, it is more than likely the standard talking points of financial industry apologists (some with fancy academic titles.) Look at where those ideas have gotten us.

I think our overall level prosperity *in spite* of legalized counterfeiting is a testament to the human spirit. As they say, people have to eat, and they find ways. It seems to me one of the greatest failures of imagination to insist that carrying so much dead weight on our backs (in the form of voracious bankers issuing fiat money) is somehow a necessary price to pay.

Mr. Wilder, we're all in your rabbit hole now and it is not a pleasant place.

[Tony]

Why can't the fed just try to constrict and expand money supplies to average no inflation and no deflation. It seems like the existing policy has been to always have a bit of inflation, which encourages borrowing and credit spending. That approach has created the credit bubble and all of this consumer debt. Wouldn't a better approach be to try to hold the value of money constant? No inflation or deflation?

Secondly, if the fed does try like crazy to prevent deflation by pumping out dollars, can't we inject those dollars into the economy from the bottom up through public works projects that actually build infrastructure instead of the Bush top down approach that just makes the rich richer? For the mortgage problem to stabilize, consumers need some of that capital so they can start paying off their debt. I'm with Krugman is calling for a new New Deal.

[Lafayette]

Pusillanimous Pussyfooters

Tony: can't we inject those dollars into the economy from the bottom up through public works projects that actually build infrastructure instead of the Bush top down approach that just makes the rich richer

How the Keynesian pump is primed will be central to Obama's efforts to get the US out of its Present Mess. He can (try to) do it by means of Tax Rebates, where there is plenty of room at the top, to free tax money. Problem is, when you've got money aplenty as it is, you don't need more of it. The rich do not spend Tax Breaks, they bank them.

Perhaps the poor do, but that depends upon how. Bringing down Credit Card debit balances is not exactly an economy-expansive measure.

Far more effective is government spending. On what? Where do we get the money?

Answer to the second question: Bush supposedly has passed the hat around the Gulf (not of Mexico) for a $250B "loan". Indubitably, we will have to go to present World Money Creditors. China, here we come. Russia? (Ohmygod! Not Russia! Putin will need it to pump up his own flagging economy.) Europe? No way, José -- they are collectively in a Debit Position. That does not leave much on the table ...

Answer to the first question: There are plenty of key Transformation Objectives that will need the expenditures, so the "BigO" will have to prioritize. There is much to be done and not enough money, presently, to do all of it. Like any PotUS-elect, he is probably thinking of what he will do first term that will get him elected second term. Which explains a lot of his pragmatic choices of Cabinet level Secretarial posts.

I suggest therefore that, the ideologists (like me), cool their tempers. BO cannot do everything at once, meaning financially. He must kick-start the economy. He must fix Health Care. As for all the rest ... I doubt he'll be getting to them much before the end of his first term. Infrastructural Renewal is mindbogglingly expensive. But, it IS Keynesian-expansion effective.

All of which brings us back to Health Care and whether he will be Truly Transformational. I doubt that as well. I suspect neither he nor Dashle will have the balls to stand up to the AMA. His campaign promises regarding Health Care were tepid at best. As I've said repeatedly, making expensive HC accessible (to the 16% of the population who do not have any) is ... uh, very expensive. (America spends twice as much per capita on Health Care as Europe for the same quality of service, but less population coverage.)

True Transformational Change would consist of what I have been opining in this blog for a year now. A secondary source of Health Care, with mandated Federal pricing of Health Care provider services (including Pharmaceuticals). This comes closest to the European model, considered to provide the best Health Care in the world. Compared to American dependence upon Private Enterprise Health Care, it would take a sea-change in mentality to bring it about.

And, I don't think that US politicians have the volitional wherewithal (i.e., True Grit) to bite the bullet and bring it about. Pusillanimous Pussyfooters, all of them.

[Lafayette]

Objective opinion

beez: Might these pauses, without informed monetary restrictions on money growth, create investment excesses--bubbles?

Yes, but I wonder, so what?

The sky is NOT falling down about our ears. The economy is functioning at less than optimal output, because of the colossal stupidity of some, not all, who were responsible for Risk Management. Our regulatory system failed. We need to reform it. But, we know that.

Let's put things into perspective vis-a-vis the Great Depression ... it is similar, but not the same. And, given the financial/economic mechanisms/policies that we have learned to put in place the past 79 years, the outcome at present is unlikely to be even remotely similar to that of the past. Don't forget, our economy took a decade to finally mend itself after the crash of 1929.

We are on the downside of a wholly conventional Economic Cycle, which we fully deserve. We've been here before. We know what is necessary. We are taking the necessary measures as best we can. (Despite the apparent bumbling about at the Treasury.)

What is amazing about the commentary in this blog, and others, is the Gloom 'n Doom that has found expression. Aided and abetted by (supposed) Economic Gurus and Economic Journalists -- who would have done us all a good deed had they showed more reserve and objectivity.

There is no need for panic. There is a GREAT need for some level-headed thinking. Which we have not got so far, especially with Paulson -- but also due to the freak accident of This Mess happening during a change of administrations. Bitching-in-a-blog about Paulson helps nothing. Ditto Bernanke at the Fed.

There is only so much that can be done in terms of policy making ... and the rest will depend upon consumers. Two thirds of our economy is driven by Consumption -- and the other third depends upon the first two-thirds. Part of the remaining third is Government Spending, which is being applied to drive a traditional Keynesian Expansion that will (hoepfully) spark the economy -- meaning simply, convince consumers to Consume. When that happens, Investment will kick-in to sustain the economic recovery.

We are perhaps forgetting, amongst all the Finance mumbo-jumbo here, that the Prime Motor of any economy is Consumption. Meaning, us.

We all believe in the fundamental liberty of expression. But that liberty, like all freedoms, comes with an inherent responsibility for Objective Opinion. The objectivity in much commentary, both in blogs and in the press, is sorely lacking.

Conclusion: Go out and buy something! Anything!!! Preferably Made in America. But not necessarily. We need to get the economy's engine turning again. It is not the moment to Save. Now is the time to spend.

Saving now simply condemns us further to the spiral downwards.

[Youmustbejoking]

when we wade through history we find bubbles invariably burst. In this particular instance, our "real" mortgage rate was a negative number, meaning we paid a 6 percent interest rate on an asset appreciating north of 10 percent. How cool was that? We were the worlds consumers, we not only drove the US economic engine we drove the entire world. Then the bubble bursts, housing prices come down and we see some indications of deflation. Which results in us now experiencing "real" mortgage rates of double digit positive numbers (our rate is 5% and the asset is now depreciating at 18% for a rate of 13%). Clearly when the assets depreciate and they are leveraged we are hurting. The solution is clear - deflate the us dollar. It solves all our problems on a global scale. We will most likely see this before the end of 09. cheers.