There’s something about inflation targeting that causes otherwise sensible people to become slightly deranged. On one side you have Bloomberg.com warning that no amount of money can cure Japanese-style deflation:
Yes, Hooters Inc. has made its way to Tokyo. Normally when hundreds of Japanese men huddle in line it’s for a new iPhone or video game. These days, it’s to be served beer and chicken wings by waitresses in white tank tops and orange short-shorts. The American chain is gaining popularity in Japan.
It’s also an unlikely sign that deflation will be with Japan for a long, long time.
Anyone who still thinks falling prices are a cyclical phenomenon isn’t looking closely. It’s secular, and the sudden ubiquity of discount outfits shows how Japanese consumption has become a race to the bottom of the pricing spectrum.
Japan used to be an automated-teller machine for brands like Prada, Gucci and Louis Vuitton. Women thought little of plopping down $2,000 for the latest fashions from Milan and Paris. Men didn’t blink at paying $200 for a tie. That’s all fashion-industry history now. Sliding wages and rising job insecurity brought budget-shopping into vogue.
No matter how much yen the Bank of Japan pumps into the economy, deflation deepens. It’s all about confidence, of which there is virtually none.
The hard core Keynesians say QE can’t work, because their models tell us it can’t work. It’s just exchanging one zero rate asset for another. Unfortunately their models are flawed, and we are seeing inflation expectations rise in response to QE, something that’s not supposed to happen.
At the other extreme you have Sarah Palin comparing Bernanke unfavorably to Ronald Reagan:
I’m deeply concerned about the Federal Reserve’s plans to buy up anywhere from $600 billion to as much as $1 trillion of government securities. The technical term for it is “quantitative easing.” It means our government is pumping money into the banking system by buying up treasury bonds. And where, you may ask, are we getting the money to pay for all this? We’re printing it out of thin air.
. . .
We shouldn’t be playing around with inflation. It’s not for nothing Reagan called it “as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.”
First of all, I think Reagan did a pretty good job on inflation. Contrary to what some Democrats argue, it was Reagan, not Jimmy Carter that is responsible for the drop in inflation from about 10% in 1981 to about 4% in 1982. He supported Volcker’s second attempt at tight money, whereas the first attempt was abandoned during the run-up to the 1980 presidential elections. But let’s not overdo things. After inflation was reduced to 4% in 1982, Reagan administration officials and conservative newspapers like the Wall Street Journal pressured the Fed to ease its monetary policy, and no further reductions in inflation were achieved. Indeed inflation was closer to 5% by 1989 when Reagan left office. In contrast, Bernanke has reduced core inflation to little more than 1%, and the TIPS market suggest inflation is likely to remain well under 2% over the next 5 years. If low inflation is Sarah Palin’s goal, then Bernanke should be her hero, not Reagan.
Palin is echoing the views of many freshwater economists. Their models tell them that Bernanke’s policies will produce high inflation. Of course they also claim to believe in efficient markets, except when those markets tell them that their models are wrong.
So which is it, deflation or high inflation? The smart money says neither:
Goldman Sachs Group Inc., which warned a month ago that the U.S. economic outlook was “fairly bad” at best, said the Federal Reserve’s decision to increase bond purchases will spur growth.
“Downside risks to the economic outlook have declined significantly,” Jan Hatzius, the New York-based chief U.S. economist at the company, wrote in an e-mail to clients. “As we move through 2011, the lagged effects of the renewed monetary easing combined with a gradual slowdown in the pace of private deleveraging should result in a substantial pickup in GDP growth.”
The Fed’s decision will lower the risk of deflation, Hatzius wrote. The Institute for Supply Management manufacturing index and the government’s employment report last week also show the economy is moving in the right direction, according to the report.
Hatzius defended Fed Chairman Ben S. Bernanke when others including E. Gerald Corrigan, former president of the New York Fed, have voiced concern that the central bank actions will lead to a surge in costs for goods and services. Bernanke on Nov. 6 dismissed the idea the central bank will increase prices to higher levels than it prefers.
There’s a reason GS makes more money that other banks, they use reality-based models, not faith-based models. I am not sure why so many economists are predicting either no effect from QE, or high inflation. This isn’t rocket science. The Fed’s had an implicit inflation target of about 2% for decades. When it’s too high they nudge it down, when it’s too low (as in 2002) they try to nudge it up. I happen to support a NGDP target, but I’m not running the show. Given their target, it’s no surprise they are trying to nudge inflation a little bit higher. Markets currently expect only 1.7% inflation over the next 5 years, even given the recently announced QE. Before rumors of QE started circulating, the expected inflation rate was only about 1.2% over 5 years. Given how much we’ve undershot the Fed’s target over recent years; I’d like to see higher than 2% inflation. But even I don’t think we’d need to go above 3% to get a robust recovery. The markets and GS are telling us the same thing. Trust the smart money, not the left and right wing ideologues.
QE has a modest positive impact, contrary to Keynesian models. But it won’t produce high inflation, contrary to monetarist models. Targeting the forecast—call it the Goldilocks model.
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