Misguided Meltzer, by Tim Duy: After scouring the Wall Street Journal for stories by competent journalists, I found myself in the op-ed section. Apparently I feel compelled to make the same mistakes over and over. In any event, I found Allan Meltzer’s latest inflation warning staring me in the face. Most of the piece is not new territory, but it has an interesting twist at the end.
Meltzer begins with the same, tired lament:
Federal Reserve Chairman Ben Bernanke sees little risk of inflation because he doesn't look in the right places. Inflation is a general increase in prices, but increases always occur at different rates. Right now, labor costs are not rising but other costs, such as the prices of raw materials, have been and are continuing to increase. Businesses will pass some of these costs to their customers. Health-care costs also are continuing to rise.
Inflation is not a general increase in prices. That is a one-time price increase, or a shift in relative prices. Inflation is a continuous increase in the price level, which, to be perpetuated, needs to be matched by increasing wages – something Meltzer admits is not happening. Without an increase in wages, the current gains in headline inflation will prove to be transitory. Meltzer then brings up the boogieman of the 1970s:
Mr. Bernanke tells us that inflation won't be a problem as long as unemployment remains at an unacceptable level. But considerable research shows that this reasoning is badly flawed. During the inflation of the 1970s, for example, the discredited "Phillips Curve"—which suggested that high unemployment and rising prices shouldn't go together—persistently underestimated inflation and misled the Fed into pursuing an ever more expansive policy. If the Fed looked, it would find many other countries that experienced high inflation and high unemployment together.
Yes, inflation can coexist with high unemployment, but only in the presence of accelerating wage growth. This combination existed in the 1970s, but not now. Look at the historical record. The path of unit labor cost growth prior to 1980 is very different from that experienced since 1980. Until unit labor costs start accelerating, fears of a return to the 1970s are misplaced. Next Meltzer tries to redefine the CPI:
Those who doubt that the United States is headed for inflation remind us that increases in the consumer price index (CPI), and the "core" CPI that omits food and energy prices, remain modest. But the CPI and the core CPI are currently misleading because 40% of the CPI and 25% of the core CPI represent housing prices and are heavily dependent on statistical estimates of what homeowners would pay to rent their homes. Most of us never see these prices and do not pay them the same way we pay for food, gasoline and health insurance.
First, Meltzer does not even understand when the data is actually poised to work in his favor. Apartment vacancy rates are falling, suggesting that rents, and thus housing component of CPI, are set to rise. Perhaps Meltzer would be happy to use the housing prices that people actually pay, but those are falling, which is not exactly consistent with his argument. Notice also that Meltzer wants to narrow the CPI down to only those items going up in price. Why not to those items going down in price? He continues:
Furthermore, the Fed treats gasoline and oil price increases as a transitory blip. That's almost certainly correct about the effect of Arab unrest or the Japanese tsunami. But much of the rise in oil prices came before these events and was in response to the strengthening world economy. Prices will likely continue to rise as the world economy grows. Meanwhile, world grain prices have been driven up by the foolish U.S. ethanol program. When ethanol raises corn prices, prices for substitutes like wheat and rice rise also. There is no sign that Congress will repeal the ethanol program.
Meltzer conveniently ignores that rising commodity prices have simply reversed the losses sustained during the recession. Apparently he would be happier if the Fed induced a recession to offset that terrible improvement in the global economy. On top of which he wants the Fed to “fix” the relative price changes induced by Congress. Good luck with that.
Then Meltzer finishes with a twist, his grand proposal to save us from inflation:
One of the Fed's recent errors was increasing the money supply by buying more than $1 trillion of mortgage-backed securities as part of its "quantitative easing" policy. Its hefty balance sheet now threatens to finance further inflationary increases in the money supply. How can it be unwound in an orderly way?
One idea is for the Fed to create its own version of a "bad bank." The Fed should promptly put the $180 billion of its long-term government debt and more than $1 trillion of its mortgage-backed securities into a separate entity. The long-term government debt and mortgage-backed securities would be the new bank's assets…
…The Fed would make a commitment not to sell any of the bad bank's mortgage-backed securities and Treasurys until they mature…
Yes, that’s right – Meltzer’s solution to the inflation threat is to tie the hands of the Federal Reserve so that they cannot liquidate the balance sheet if necessary. More:
…Almost half of the Fed's currently held assets, more than $1 trillion, have 10 or more years until maturity, so all of them would be off the table as far as financing inflation during the gradual economic recovery. As the mortgages mature and are paid off, the bad bank's assets decline. The reduction in the bad bank's assets means that its liabilities, the excess reserves, would also decline—though that would be years away.
No, if the Fed cannot sell the assets, then they are not “off the table,” they are the centerpiece of the table. If you are worried about inflation, you don’t want to entrench a system that ensures that excess reserves would decline “years away.” You want the exact opposite – to drain the reserves right now.
Rather than admitting that the Fed has not induced a monetary collapse, that the world has not ended, that Treasury rates are mired below 4%, that he is simply wrong, Meltzer offers a completely backwards policy proposal. A short step from there to complete irrelevance.