Sunday, June 21, 2009

Alan Blinder Wades In

The New York Times is going to become required reading for my economics classes at the University of Virginia. Hardly a week goes by without a major article on the economy that is replete with economic fantasies. Today's edition continues in that tradtion. This time, Alan Blinder, Economics Professor at Princeton, is the culprit in a bizarre article entitled "Why Inflation Isn't The Danger." This article is so full of mistakes and factual inaccuracies that I think Blinder ought to receive some kind of award for creative thinking.

Lets begin with the federal funds rate discussion. According to Blinder, "the central bank is holding the fed funds rate at nearly zero...." Actually, Alan, the Federal Reserve, contrary to your assertion, does not set the federal funds rate....the market sets the federal funds rate. The Fed sets a "target" for the federal funds rate. That target may or may not approximate the actual federal funds rate. On December 16th, 2008, the market, not the Fed, had already taken the federal funds rate to near zero. The Fed, at the time, with its head in the sand, had their target for the federal funds rate at one percent. What to do? The Fed could keep their target rate at one percent, ignoring the fact that the actual federal funds rate was trading at near zero. But that would make it obvious that setting a target for the federal funds rate is a stupid policy if the actual rate doesn't trade anywhere near the so-called "target." So, the Fed lowered its target rate from one percent to "near zero," basically catching up with the facts of the market place. Heck, maybe I should set a "target" rate. I could get it closer to the actual rate than the Fed does. The market set the federal funds rate at near zero because of a "flight to quality" that is still ongoing. When the flight to quality ends, the funds rate will begin to rise (even if the Fed has its head in the sand or some other place). The market is a more important determinant of the federal funds rate than the Fed. Who cares what the Fed's target for federal funds is? All that matters is what the federal funds rate actually is in the market place, not some irrelevant target number announced by the Fed.

Blinder goes on to correctly note that the implied inflation rates of TIP securities is about 1.6 percent. He concludes from this that the market has decided there will be no inflation. Good going Alan. I guess you bought stocks when the Dow traded at 14,000 in October of 2007 because the market was forecasting a good economy going forward. Right?

Wake up and smell the coffee, Alan. Not only is the Fed adding to its balance sheet by the bucketload, but it is also buying treasury securities and mortgage back securities outright in the market place and, surprise, surprise, all measures of the money supply are growing....a fact, you conveniently ignore in your article. While excess reserves have increased (a lot) in the commercial banking system, so also has every conceivable measure of money supply and liquidity.

Here's another laugher, Alan: "...history teaches us that weak economies drag down inflation." Are you joking, Alan. Let's begin with the most famous inflation in world history...the German hyperinflation of 1923 that accompanied the weakest German economy in history. If that's not a good enough counterexample, lets look at the good ole USA. The 1970's were known as the decade of "stagflation" -- high unemployment, sluggish economic growth, and the worst decade-long inflation spike in American history. What about the converse? Are their periods of deflation and strong economies? Yes. The fastest fifty years of economic growth in American history is the period between the American civil war and World War II. What was happening on the inflation front during this period of extraordinary economic growth? This was a period of deflation with price levels falling by over a third over most of this period with an average deflation rate of nearly two percent for much of the period (recall William Jennings Bryan's "cross of gold" speech). For another example, try the US of the 1980s and 1990s -- a period characterized by strong economic growth and low inflation. So where is this history that teaches us "weak economies drag down inflation."

Here's what history actually teaches us: There is no example in history...yes, no example in history...of an economy with rapidly growing money supply not followed in time with rapidly rising inflation. Yes, no example. Go find one...there are none.

So, Alan, I know you want to support your pal Ben. Heck, we all want to support Ben. But, Ben just isn't supportable, Alan.

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