The best way to describe Fed actions over the past few years is that of an asymmetrical policy. Slash rates when the economy was faltering and the financial system was facing extraordinary stress and keep them at zero even after the emergency has passed and the economy has stabilized, however fragile. This begs the question of when does the Fed raise rates. Will the timing be up to them or will the bond market force their hand. A key component of the Fed’s comfort with keeping rates so low is their belief that “with substantial resource slack likely to continue to dampen cost pressures and with longer term inflation expectations stable” inflation will remain subdued for some time, according to their last FOMC statement. The Fed’s Plosser in a speech given today doesn’t fully agree. He believes there is evidence “that finds that economic slack or low resource utilization is not a very reliable predictor of inflation” and “ultimately, inflation is a monetary phenomenon and there is no question that current monetary policy is extraordinarily accommodative.” He said with “competing views of the economic forecast and the underlying structure of the economy driving that forecast” it will be a challenge to “withdraw or restrict the massive amount of liquidity that we have made available to the economy.” Getting back to the when question on hiking rates, Plosser said as the economy grows and real interest rates rise (market rates), “the fed funds rate should be permitted to rise with them.” In other words, he believes the bond market should dictate when the fed should act, maybe leaving less subjectivity to the process and I believe in contrast to many other Fed members who likely will want to wait until well after market rates have shifted in response to an improved economy and/or higher inflation.

Category: MacroNotes

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6 Responses to “Fed’s Plosser says inflation is a monetary phenomenon, in contrast”

  1. djackson says:

    Several points. First, context on Plosser. He is probably best associated with the “freshwater” school which is a distinct minority in the Fed. Additionally, he does not have a vote until 2011. Second, for all the angst expressed about the future of the Fed, in this crisis it became thoroughly politicized. How else to explain Bernanke’s actions from TV interviews earlier this year to a recent editorial essentially campaigning for Senate confirmation. They will wait as long as possible, i.e., too long, so as to avoid the political fallout attendant to a ‘pre-emptive’ withdrawal of liquidity. They will not just want to see the ‘whites’ of the eyes, they will be close enough to do a retinal scan of the recovery.

  2. mickslam says:

    We have 10% unemployment, and less than 1% inflation. The dual mandate is still in effect as far as I can tell, so complaining today about potential inflation is lame.

  3. Pat G. says:

    He should be careful. Those kind of ideas might actually begin to catch on around the Fed and hurt all my investments…

  4. demand side says:

    Plosser’s point of view is just scary. “Inflation is a monetary phenomenon.” Didn’t seem to be a monetary phenomenon when oil prices went to $145 and pulled prices up. Hard to see how the money stock then collapsed with the oil price and brought inflation back down. Or now, with Bernanke’s heroic attempts to turn a fire hose of money loose, and no inflation. How does that compute with “monetary phenomenon?”

    Perhaps if Plosser could see the immense destruction of money in the deleveraging event now going on, we might credit him with some sense in such a statement. But this is not what he is talking about. The phenomenal debt to GDP ratio is completely invisible, even now, to everyond at the Fed. Debt deflation is not, as far as I can tell, on the radar. These guys are dangerous.

  5. constantnormal says:

    @demand side 12:39 am

    Agreed. I see the vast, unknowable mountains (now that market-to-market is gone, and we have no way of assessing the size of those mountains) of toxic debt as “negative credit” — i.e., debt that returns losses instead of gains, destroying money instead of growing it via interest.

    If we had mark-to-market accounting, we would then have some means of assessing just how much negative credit is out there (and we could at the same time, zero it out via the bankruptcies of the holders thereof), and that would make the credit build-up a good deal less fearsome.

    But we don’t know how many trillions of negative credit are out there offsetting the Feral Reserve™’s copious expansion of “good” credit (“good” at least until the Treasury begins to play the Dubai game and tries to avoid paying the balance due). So until there is a Reality Check, and a proper accounting of the good and bad credit out there, we will not know just what the inflationary risks really are.

  6. demand side says:

    @constantnormal 12:30 12/4

    Well put. Negative credit. That is really quite a useful conceptual tool. Thanks.