Thursday, July 29, 2010

More Inflation / Deflation Debate

Article in the NY Times about the great inflation / deflation debate.

They call those Fed chairmen worried about deflation as doves and those concerned with inflation as hawks.

James Bullard, of the St. Louis Fed, looks like he went from a hawk to a dove:

On Thursday, James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”
These are pretty scary words as a Japanese-style deflationary spiral , or the lost-decade, as it is known in Japan has many different outcomes and not many of them are pleasant.

One is a persistently high unemployment, especially for younger people who must accept lower wages as the older workforce does not retire. There is a decline in the lifetime employed and an increased use of temporary labor and the acceptance of dead end jobs.

At the end of the article is mentioned my long time Fed hero Richard Fisher, of the Dallas Federal Reserve bank. He is a hawk.

I can always depend on Mr. Fisher to put it all in perspective. Here is his latest speech on the state of the economy.

Mr. Fisher believes that all the policy changes and a lingering uncertainty are responsible for the lack of action on the part of businesses.

The bottom line is this: In whatever realm and whatever form, excessive uncertainty is the enemy of economic growth. As Ben Bernanke wrote in 1980, the “resolution of uncertainty” can lead to “[a business] investment boom.” It follows, then, that if and as regulators and legislators provide more clarity, a major roadblock to economic growth will be removed.

It was recently reported that nonfarm, nonfinancial firms in the U.S. have over $1.8 trillion worth of liquid assets sitting on their books. Excess bank reserves being parked in the 12 Federal Reserve Banks exceed $1 trillion. If and as the incidence of
“random refereeing” and uncertainty is assuaged, then we might well have the opportunity for robust growth in employment and capital expenditure expansion as firms and banks put that excess cash to use. That’s the good news.

I would agree. People save money as a buffer against uncertainty and most people put off investments until they know which way the wind is blowing. In economics we have the concept of long term vs. short term. People only live in the short term, the day to day, the marginal occurrences that make up your lives.

People plan for the long term, what their overall goals are and what it is they are working towards. People never reach the long term, it is like the end of a rainbow. It is the equilibrium point where supply and demand are in balance and the whole economics profession makes sense. Economic fundamentals work in the long run we can tell you what the overall state of affairs is going to look like, but we cannot tell you exactly how we are going to get there.

We don't know if there is inflation or deflation going on in the short run. We know that if unemployment remains high and the economy is in a type of liquidity trap, then we should have deflation in the long term. We also know that if the Fed continues to expand its balance sheet, there will be inflation, greater debt, crowding out of private funds and higher taxes in the long run.

How can we plan for the short run when we can't even agree on what the long term equilibrium point is supposed to look like?

1 comment:

Anonymous said...

Paul Krugman talks about Japan-Style delation in his blog post