Wednesday, May 06, 2009
There's nothing more fun than a cat fight between economists as the recent dust-up between two economics professors clearly demonstrates.
The subject felines are Allan H. Meltzer, the author of "A History of the Federal Reserve", and Paul Krugman, Nobel Prize winner and columnist for The New York Times.
[Note: There are two "l"s in Meltzer's first name, something that may have been involved in the heightened tension that developed yesterday.]
Naturally, the disagreement has to do with inflation, the bane of all economists everywhere.
It began with a harsh critique of monetary policy over the years by Meltzer in this New York Times op-ed on Sunday in which the commitment of the central bank was questioned when the time comes to decide between fighting inflation and bolstering employment, a choice that could come for policy makers as soon as later this year.
Paul Volcker is now the head of President Obama’s Economic Recovery Advisory Board. Mr. Volcker and the administration’s many economic advisers are all fully aware of the inflationary dangers ahead. So is the current Fed chairman, Ben Bernanake. And yet the interest rate the Fed controls is nearly zero; and the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain. Still, they all reassure us that they can reduce reserves enough to prevent inflation and they are committed to doing so.Here's where it gets interesting...
I do not doubt their knowledge or technical ability. What I doubt is the commitment of the administration and the autonomy of the Federal Reserve. Mr. Volcker was a very independent chairman. But under Mr. Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury: bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as much as $700 billion of reserves to buy mortgages.
Some of my fellow economists, including many at the Fed, say that the big monetary goal is to avoid deflation. They point to the less than 1 percent decline in the consumer price index for the year ending in March as evidence that deflation is a threat. But this statistic is misleading: unstable food and energy prices may lower the price index for a few months, but deflation (or inflation) refers to the sustained rate of change of prices, not the price level. We should look instead at a less volatile price index, the gross domestic product deflator. In this year’s first quarter, it rose 2.9 percent — a sure sign of inflation.Krugman thought a history lesson was in order in this item at his blog:
Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.
When will it come? Surely not right away. But sooner or later, we will see the Fed, under pressure from Congress, the administration and business, try to prevent interest rates from increasing. The proponents of lower rates will point to the unemployment numbers and the slow recovery. That’s why the Fed must start to demonstrate the kind of courage and independence it has not recently shown.
A history lesson for Alan MeltzerAnd the response by Meltzer yesterday afternoon:
From today’s Times:
Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.Japan’s lost decade:
After I published a piece in the New York Times op-ed page warning of future inflation (see: “Inflation Nation“), Paul Krugman claimed to offer me a “history lesson” on his Times blog (see his post: “A History Lesson for Alan [sic] Meltzer“).There is no word yet on anything new from Krugman.
In the piece I argued that no country with rapid money growth, a large budget deficit, and an expected depreciation of the exchange rate has ever experienced deflation, always inflation. He claims Japan’s “lost decade” as a counterexample. It is not. I am very familiar with Japan during this period—I served as honorary adviser to the Bank of Japan and met often with the then Governor Hayami. He opposed using monetary expansion, and I did not convince him that he was making a mistake. In the midst of the deflation, he raised the interest rate to avoid “sloppy” money markets. That was the wrong thing to do as several of us told the Bank of Japan at the time.
When Governor Fukui replaced Governor Hayami, he carried out the policy that I had urged Governor Hayami to follow. He bought long-term bonds.
The deflation ended, contrary to the advice of Professor Krugman, who claimed at the time that monetary policy was in a “liquidity trap” and useless. He was wrong then and he neglects that, unlike the United States today, Japan financed its excess spending from domestic saving. We have to borrow from others. The Chinese have sent several signals warning that they may be reluctant to finance our outrageously large deficits.