Friday, February 20, 2009


Dave Burris responded sharply to my previous post on inflation, defending himself by saying he wasn’t criticizing President Obama, but the Federal Reserve Bank. On DelawareLiberal, Dave offered this comment:
I discussed many times on the air with Randy that the hidden problem was not TARP, but the trillions of dollars that the Fed was playing around with.
Since I don’t listen to talk radio, I missed his on-air comments on the subject. So I went back and checked Delaware Politics, and I did find one post that warns that TARP could inflate the money supply; this written by Dave Anderson.
So my failure to infer that Dave Burris was talking about monetary policy, not fiscal policy, was based on the public record, or lack thereof: Dave hadn’t written that monetary policy might be fueling inflation since the crisis erupted last fall.
But to be fair, saying that monetary policy rather than fiscal policy could be fueling inflation is plausible, and not loony. I still think he's wrong about inflation, but at least we have a basis for talking.
So let’s talk. Is the Federal Reserve risking inflation with its monetary policy? The Fed’s Open Market Committee (FMOC) doesn’t think so:
In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.
The minutes from the last FOMC meeting sheds further light on the subject:
Several meeting participants noted that the expansion of the Federal Reserve's balance sheet along with continued growth of the money supply could help stabilize longer-run inflation expectations in the face of increasing economic slack and very low inflation in coming quarters. Over a longer horizon, however, the Federal Reserve will need to scale back its liquidity programs and the size of its balance sheet as the economy recovers, to avoid the risk of an unwanted increase in expected inflation and a buildup of inflation pressures. Participants observed that many of the Federal Reserve's liquidity programs are priced so that they will become unattractive to borrowers as conditions in financial markets improve; these programs will shrink automatically.
In other words, the Fed recognizes that it will have to squeeze money back out of the system as other sources of liquidity are freed up.
Be in no doubt; the Fed did add liquidity to the system starting last fall. M1 and M2, the two principle measures of the money supply, are 14.9 and 9.6 percent higher than a year ago, as they should be, though they are showing signs of peaking. Total borrowings from the Federal Reserve, which reached $698.8 billion in November, are starting to come down again.
So is this extra money fueling inflation?
So far, no. The wholesale and retail inflation reports both cite energy prices are the principle factors driving increases in January. The New York Times reports that the increase in fuel prices reverses several months in declines:
Inflation crept back into the economy last month as consumer prices rose slightly after three months of declines, the government said Friday. The increase came as a steep slide in oil prices ended, lifting the cost of gasoline, energy and transportation.
Fuel prices don’t correlate very well with money supply. If they did, they would have jumped, not slumped, in the last quarter as the Fed increased liquidity.
In fact, consumer prices have only just recovered from the end of October. The Times reports that most observers agree with the Fed that inflation is not a worry just yet:
But analysts expect that the sharp downturn in the economy will probably keep inflation pressures in check in the months ahead. Indeed, prices in January were flat from a year ago, and economists said prices could continue to tumble as unemployment surges and spending weakens.
I don’t see industrial demand pushing prices up. Capacity utilization is down 10 percent from a year ago. Overall, the January numbers showing higher prices reverse three months of deflation.
So while Dave’s concern about monetary forces pushing inflation up is plausible, the evidence doesn’t support his view just now. Still it’s better than bending the laws of causality to suit your argument.


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