Tuesday, January 19, 2016

2% Inflation and the Fed

The Fed seems to have a thing about 2% milk. Or was that 2% inflation? It has become a passion with them. It’s like your mom when you were a kid. Honey, if you are good we will take you to Legoland. What is good Mom? To start with clean up your room. And then you should get straight Bs. Straight Bs? Why do I need straight Bs to be good – good enough to go to Legoland?

Mom knew that I would never get straight Bs. I could hardly sit in my school desk for five minutes let alone concentrate long enough to get a B on anything. The Fed has been singing this 2% inflation song for quite a while – and all during that time the chance of inflation reaching 2% was about the same as my getting straight Bs.

Why is the Fed so disingenuous? Mostly to take our collective eye off the ball. There used to be a time when the proper role of the Fed was to provide just the right amount of liquidity to the economy and restrain inflation. But then the Keynesians messed things up and suggested that since the government is totally inept, the only organization besides Donald Trump left to control the economy is the Fed. So instead of humbly trying to  dampen inflation and inflation expectations the Fed has turned into this multi-headed hydra doing everything from dunking basketballs to fine tuning the unemployment rate.

Janet has no troubling dunking so she and her fine fellows at the Fed (notice all the Fs) have spent the last 8 years or so telling us bedtime stories about monetary policy and the unemployment rate. Janet will not rest until every last legal and illegal fast-food server has a full time job with rapidly growing wages. She is still a long way from reaching that goal so she is even more dedicated. But here’s the rub. Aged economists like myself keep reminding her that at some point after she has poured enough money onto the smoldering economy she will have created enough economic and financial imbalances to sink a manatee.

Janet wants to please even old guys like me so she gives what we might call “lip service” to the idea of inflation. Janet wants unemployment much lower (and wages much higher) and will say just about anything so she can say she slayed the employment dragon. One thing she can say is – look dudes. I poured enough money on the economy to drown China and look – no inflation. Well – there is some inflation so she had to come up with a number for the perfect amount of inflation and that number is 2%. She keeps pointing out that inflation is less than 2% and she acts as if that is a bad thing. Is it a bad thing when your money buys more? Instead of saying she wants the unemployment rate lower – she chides us with this silly statement that inflation is less than 2% and that is a bad thing! Worse – she says – we must keep stimulating the economy until we can get inflation up to 2%. 

Up to 2%!!! Am I yelling? I spent my whole 169 year career thinking the Fed is supposed to REDUCE inflation. Where did we get this raise inflation crap??? It is just like those straight Bs. Mom didn’t want to take me to Legoland. Janet does not want to raise inflation to 2%. What Janet really wants is a gold star for employment achievement.

You say – but Larry – the Fed just raised the interest rate. Are you never happy? Did you never get to Legoland? Yes, I did get to Legoland and it was wonderful. As the Fed announced its miniscule increase in the interest rate it spent more words reassuring us that the future increases will be so gradual that no one will even notice. But even that tiny little interest rate increase isn't guaranteed. If ANYTHING comes up this year that has even the tiniest possibility of slowing growth in the US economy you can be sure that the Fed will end their attempt to restore a bit of normalcy to monetary and financial conditions.

2% inflation is a gimmick and it means nothing. What matters is the Fed’s progressive agenda and that it is riveted on the unemployment rate and economic growth. Mark my words. If the inflation rate rises close to or above 2% while the employment situation is not sufficiently solved – the Fed will explain why 2% was never a rigid target. The Fed will then explain why 3% makes more sense. Hey guys, is 4% really so bad? 

Why am I so mean about the Fed? The answer is that they don't read the handwriting on the wall. First, remaining issues with employment have nothing to do with monetary policy and everything to do with long-term structural issues. Loose money and low interest rates are doing little for growth and everything to increase imbalances. Second, we already see the worrisome bubbles developing that arise from near-zero interest rates. Third, if inflation does begin to rise despite little progress on employment, the Fed will likely ignore the inflation and will end up creating a very unstable stagflationary environment. Those of you who experienced all that in the 1970s know why that is not a desirable end. 

The Fed should stop this charade about wanting a higher inflation rate and just tell the truth. They are not going to stop this abnormal monetary policy until every last one of us has a full time job and wages are growing faster than kudzu. Domestic and global imbalances be damned. 


  1. Non of the Fed's wishes about spending and employment are going to happen real soon. Why not? Well inflation also happens with demand exceeds supply and a bubble occurs. Product prices move up beyond their real value. If the bubble is controlled the same thing may occur anyway. However, to have significant spending requires a change in income to support it. Buying on long term credit due to low interest rates is not the answer because sooner or later the credit balance has to either be paid down out of savings or credit extension. Savings do not occur unless there is a change in income upwards to support it in excess in the change of prices for goods and services. The income has not done this. It has remained relatively flat both because of inflation for most things and employers keeping the profit for growth. The Fed cannot change the economics of global trade which in tern is driven by low wages and access to digital products and communication. We are going through a transformative process. So the question is what can the Fed do. My opinion is to drop the liberal stance, get an understanding about the transformative process and reinvent itself.

    1. Your opinion is dead-on Hoot. How long does it take for the Fed to understand that it is not providing any cures for employment? Yellen should be leading the charge for good government and making it clear to government that the Fed has done all they can do. It is now time for government to grow up and face the real challenges of our time. There are always lots of problems out there but now is the time for Congress to focus on employment and output growth. The best way to start is to address all those obstacles to both labor supply and labor demand. The rest is window dressing.

  2. Dear LSD. Hey, lighten up on Janet/Fed . . . . they’re just trying to jack up inflation expectations hoping that inflation will in fact occur . . . . it’s called the Theory of Expectations . . . . if you expect something hard/long enough it will happen. I’m still expecting Sophia Loren to call me for a tryst, but now that she’s 81 I’m not sure I want to continue expecting/hoping . . . . and I’m getting tired of holding my breath.

    The Fed doesn’t really have any cures for unemployment other than to control the money supply and interest rates—neither of which is effective without accompanying govomit policy, which itself has been ineffective/AWOL.

    I doubt govomit will grow up and face the challenge unless Rs win the WH (and keep the majority in the House and increase seats in the Senate), Ryan follows through on his words to propose tax cuts/reform, and the new POTUS tears up many of the thousands of regs imposed during the last seven years.

    Sure, I’m holding my breath on that, too. But, hey . . . there's always hope and change . . . maybe Sophia will call.

    1. Funny thing Tuna...Sophia called me up the other night. She said she tried to reach you but you never answer your phone. The theory of expectations can work either with you or against you/ No one believes the Fed can engineer a near-term rise in inflation and thus inflation expectations are lower than a snail's belly. (Tunas would know about such things). It is not a pretty sight when you run out of bullets....

  3. Well the Gov is focusing on giving home mortgages to illegals. They have most of the low level jobs and this would promote home ownership until the first mortgage payment is due and the bank ownership.....backed up by Fannie Mai with bailouts to follow. I heard that this AM on FOX News

    1. Listen to music...it will calm the savage beast. Or so I have heard.