Greg Mankiw had a editorial in the NYT last week that is still on my mind, "Economic View: It may be time to go negative" The argument is very simple. With interest rates close to zero there may be limits to what the Fed can do to interest rates. The objective is to push down interest rates to get savers to spend. If inflation is higher than nominal rates then you can get negative real rates which should be stimulative. The problem is getting inflation to occur hen there is a strong output gap. The US economy is facing deflation so there has to be a change in inflation expectations that would have the economy believe there will be inflation. (We think the long-end of the yield curve knows it, but we have to convince everyone who is holding cash.)
The extreme example by Mankiw is that we just devalue a percentage of all currency by the end of the year through a lottery. This will not happen, but it provide a good illustration of what we want to happen to get people to spend today. Nevertheless, inflation is a tax that devalues a portion of our cash, so lottery example is not that far off.
The more logical and doable alternative is to set a hard inflation target. The target would not be like wart we do in a normal economy but a target which would cause the Fed to pure money into the economy until the inflation rat increases. No matter what happens, money will flow until inflation goes higher.
Now we are having some signs of positive economic news but the scenario of higher inflation is on the table and could represent a choice by the Fed that can be operational.
As James Tobin the Keynesian said, "there are worse things than inflation and we have them." Unfortunately for most americans inflation may be worse than a recession.
The extreme example by Mankiw is that we just devalue a percentage of all currency by the end of the year through a lottery. This will not happen, but it provide a good illustration of what we want to happen to get people to spend today. Nevertheless, inflation is a tax that devalues a portion of our cash, so lottery example is not that far off.
The more logical and doable alternative is to set a hard inflation target. The target would not be like wart we do in a normal economy but a target which would cause the Fed to pure money into the economy until the inflation rat increases. No matter what happens, money will flow until inflation goes higher.
Now we are having some signs of positive economic news but the scenario of higher inflation is on the table and could represent a choice by the Fed that can be operational.
As James Tobin the Keynesian said, "there are worse things than inflation and we have them." Unfortunately for most americans inflation may be worse than a recession.
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