Wikinvest Wire

Meltzer doesn't buy the Fed exit strategy

Thursday, January 28, 2010

In a WSJ op-ed this morning, Federal Reserve historian Allan Meltzer is not optimistic about the prospects for the central bank to "thread the needle" when it comes to removing the massive amount of liquidity that has been injected into the system in recent years.

Federal Reserve Chairman Ben Bernanke has explained his exit strategy to prevent future inflation. The Fed recently began to pay interest to banks on the reserves they hold in their vaults. Using this new tool, it claims the ability to get banks to keep the money instead of lending it out, thus containing the money supply and inflation.

I don't believe this will work, and no one else should.

The exit strategy is incomplete. Proponents are guilty of practicing economics without prices. They never say what the interest rate on reserves must be to get banks to hold the approximately $1 trillion of reserves above the minimum they're legally required to hold. That's the critical question.

The efforts to reduce inflation during the 1970s failed because they ended prematurely. And they ended prematurely when business, unions, Congress and the administration objected loudly to the rising unemployment accompanying higher interest rates. Today's high current and prospective unemployment rates pose a similar dilemma.
Based on where we are find ourselves today, the chances of commodity-driven inflation rising rapidly in the years ahead would seem to be far greater than for employment to do the same, all of which makes the Fed's job of balancing it's two aims - stable prices and low unemployment - much more difficult no matter how they go about doing it.

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Anonymous said...

The only way for the central bank to pay interest is to print more money. Think about it. To compensate for printing over a trillion dollars the central bank's plan is to print even more money. Its completely absurd.

Anonymous said...

The Keynesian dual mandate is based upon a closed system. That is, if domestic citizens stuff cash in their mattresses, the central bank is de facto borrowing the mattress money to loan out. As long as CPI prices are still allowed to go lower as productivity improves.

However, in an international system, where only one country has a dual mandate, this won't work. If Chinese citizens stuff gold in their mattresses, US central bank printing won't borrow the Chinese gold. All it will do is to confiscate goods/services produced by domestic citizens. In effect, the median standard of living will gradually fall over time.

US citizens will wind up working two jobs plus overtime to make ends meet, when one used to be enough. Which is exactly what happened. The central bank de facto confiscated the entire productivity gain for the last few decades, and then some.

Of course, this happens so slowly that the average citizen doesn't notice. When they do notice, the central bank blames oil or some such (relative price increases), and confuse citizens as to the cause. The CPI is then fudged to pretend that the whole process is not taking place.

Its all a big scam to steal resources via printing, with nonsense rationalizations promulgated as ceaseless propaganda. That is, the people are being lied to, but they don't know it. Orwellian double speak at its finest. As President Thomas Jefferson warned long ago:

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around the banks will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered."

Tim said...

For an interesting development on that Thomas Jefferson quote, see this item from yesterday.

Anonymous said...

The Keynesian logic is not even sound within a closed system. It fails to recognize that real savings is the source of aggregate demand and not the other way around. So, it does not properly address the consequences of depleting valuable savings to artificially shift aggregate demand forward in time. The result is always that future demand fails due to both a depletion of savings and its malinvestment that leads to lower productivity. You become richer by saving, reinvesting it to become more productive, rinse-lather-repeat, leading to more saving and again higher productivity ... not spending more than you have on stuff you don't need. Common sense.

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