Semi-Daily Journal

"The economy, nonetheless, has yet to exhibit sustainable growth."

That is the point, there really is still no evidence of sustainable growth. The stock market has priced in a boom, the Fed see no evidence of sustainable growth. Oh well.

Some still argue inflation is more of a threat than deflation. See, e.g.,
http://www.tnr.com/doc.mhtml?i=20030707&s=scheiber070703

I don't understand the logic.

Some still argue inflation is more of a threat than deflation. See, e.g.,
http://www.tnr.com/doc.mhtml?i=20030707&s=scheiber070703

I don't understand the logic.

There is selective pricing power in the economy, but not general pricing power. Pfizer may have considerable pricing power for a drug, while Ford has little pricing power for any product. Even with the price of oil about $30 a barrel, and the sharp rise in the natural gas price, there is little general inflation. World demand is simply too weak, world competition too strong for general inflation to be a worry just now.

One consequence of the Fed policy is that it is fueling a housing bubble with inflation and overbuilding in the housing sector. At the same time it is not having the intended effect of stimulating business investment.

I don't see much advantage to the Fed policy of lowering the prime below 3% let alone below 1%. Are they just replacing the stock bubble with a housing bubble? Are they trying to jump start the economy with impotent monetary policy when a potent fiscal policy is the real answer? If business investment is past the point of responding to interest rate cuts, why keep cutting the rates? When business investment finally returns, will the housing sector collapse with increasing interest rates and set back a recovery? Or will the Fed keep interest rates low and let the housing bubble grow really big?

IMHO, it was a mistake for the Fed to attack the stock bubble by tanking the economy with high interest rates in the late 1990s. Monetary overcorrecting is not going to fix an investment problem.

There may be a housing bubble, but there is surely a bond bubble. Americans are net creditors, but fixed income products are giving off little income. The Fed is trying to stimulate growth, but this post-stock-market-bubble environment is causing the Fed to distort the prices of other assets. Also, stock are quite quite expensive!

I agree that the super low interest rates are distorting the prices of other assets. When does this distortion become counter productive? My question is why distort other assets if the policy (super low interest rates) is not producing the desired result.

Deficit spending will only stimulate the economy if the money is spent or invested productively. The result of huge tax cuts to the wealthy is to help fuel the housing bubble, the new stock bubble and the bond bubble. Supposedly, increases in the money supply make more money available for purchases and productive investment. But if all the increase in the money is being hoarded by wealthy gets is that really an increase in money supply? Government hoarding vs private hoarding. This administration is too ideologically bound to recognize its own self interest.

>>Some still argue inflation is more of a threat than deflation. See, e.g.,
http://www.tnr.com/doc.mhtml?i=20030707&s=scheiber070703. I don't understand the logic. <<

Neither do I.

Inflation pressures usually come about as wages rise due to labor shortages. The last time I checked, the labor pool had gone global. Nike and the clothing industry are making products in SE Asia and Central America. Electronics manufactured in Korea and China. Computer tech support in Bangalore. Exactly where is wage inflation going to appear? On top of that, we have had a GOP Congress that has suppressed the minimum wage to very low levels over the last decade. So that will not work either. Bush refuses to bail out the States that are cutting projects and laying off workers that are domestic and not foreign and there are salary freezes, hiring freezes, etc. so there is no wage inflation there either.

As demand for labor remains slack, wages will decline because of less hours worked, fewer people working and underemployment. How does inflation appear under this scenario when people can afford to buy less?

Moving away from deflation means increasing jobs and increasing wages. Cutting interest rates to the bone did not work in Japan. Why should it work here? Jobs programs in Japan have helped but have not been the complete solution. Is the work contributing to the future and future productivity?

We need a fiscal stimulus that will help launch a new wave of investment and employment. Renewable energy would seem a good area that will need to expand in the future and could benefit from government investment. The tech bubble has burst. A new area will lead us into the future. Are our leaders creative enough to lead us there?

That TNR article seems to be a TNR (and Slate) special, meaning "Let's take some point of convetional wisdom and argue why its wrong, no matter how tenuous the arguments are!"

Paul wrote:

"Some still argue inflation is more of a threat than deflation. See, e.g., http://www.tnr.com/doc.mhtml?i=20030707&s=scheiber070703
I don't understand the logic."

Brad wrote: "I agree"

There are some who look to how the dollar is now trading against gold and foreign exchange and conclude from those markets that there already is sufficient liquidity in the economy to terminate any deflationary risk that might have earlier existed.

If the Fed has already ended any liquidity scarcity that had existed and is incorrectly thinking that the current slow economic expansion poses deflationary risk, then the Fed may be creating the potential for future inflation.

"Deficit spending will only stimulate the economy if the money is spent or invested productively."

Productivity is irrelevant for deficit spending. Productive investments are a nice added bonus, that might add to the economy's future ability to produce, but the point of deficit spending is to make up for shortfalls in aggregate demand in the here and now. Unemployment means that the economy is not producing as much as it could, and deficits help to mobilize those unused resources. Increaseing productivity just means the same people who are working now can produce more stuff: nice, but doesn't address the problem.

The asset price distortion/bubble argument has a couple of problems, I think. As regards the assertion of a bubble, it seems pretty hard to overcome the Fed's argument that you can't know there has been a bubble till after it pops -bubbles are defined by being popped, not by asset prices being above some historic norm. The problem with pointing to asset price distortions as a problem is that, well, they are the solution to the problem the Fed is trying to address. The rise in asset prices is part of the transmission mechanism for monetary policy. It is very hard to argue the tranmission mechanism isn't working. Such arguments tend to come down to saying the mechanism isn't working the way one would like. One person's "housing bubble" is another "leading sector". If asset prices had not risen in response to Fed easing, there would be a very strong argument that monetary policy wasn't working. The fact that equity prices have now joined bond and real estate prices in climbing is arguably a sign that liquidity provided by the Fed is making its way into wider use - a good sign.

Now, if you want a reason to worry, how about the Fed being done? The Fed seeming to be done could have serious consequences for household and corporate debt refinancing and for the dollar.

Treasury prices may have overshot do the downside, as investors trying to play the next (yesterday's) Fed ease moved out the curve where yeilds were better and volatility higher (a good thing when looking for gains). If the Fed is done, then hopes for Fed-induced gains evaporate and long rates will rise some more.

The dollar, which could provide real stimulative effects if it remains soft, has been creeping higher, even steadying against high yielding currencies like the Aussie and Loonie. There is now talk of a carry-trade getting underway from yen and Swiss francs into the US dollar, predicated again on the notion the Fed is done easing, so returns to a carry trade are now more stable.

The problem still remains that, in the short and long run, US national fiscal policy is at odds with a proper remedy for the economy. As many have already pointed out, aggregate demand is down, and it still looks unlikely to pick up.

So, in theory, some tax cuts are appropriate. The problem is that they are unfocused, backloaded, and while they will have some stimulative effect, they are remarkably weak for their price tag.

Couple this with state governments cutting back their spending and you have a neutral (at best) effect of G on aggregate demand.

Also, is anyone else worried that the stock market is in a bubble? I know people don't tend to think so because we remember the heady days of the Dow sitting at 11,000 (Or 36,000 if you're Glassman), but by traditional valuation, stocks are inflated. Am I the only one concerned about this?

sz

SZ- On average stock prices are overvalued. You are not the only one worried about this. Many think we are in a secular bear marktet and the current bull run will not last. Either stock prices will collapse or we will go sideways for a long time.

Jimbo- "Deficit spending will only stimulate the economy if the money is spent or invested productively."

By focusing only on productive investment, you missed my point. Deficit spending by the government can stimulate the economy if that deficit is used to buy goods and services. It can also stimulate the economy if it is invested in business capacity to produce goods and create jobs. Deficit spending DOES NOT stimulate the economy if it amounts to money being transferred without producing jobs or being spent. Huge tax cuts are being given to wealthy individuals who already buy everything they need. With overcapacity, there is little place to invest the money to create jobs. So they buy the government bonds issued to cover the debt at inflated prices creating a bond price bubble.

How does the government going into debt by giving money to wealthy people who then buy bonds issued to cover the debt do anything to stimulate the economy???? It does absolutely nothing. It is merely a transfer of funds from the treasury to the pockets of wealthy campaign contributors. Thus, this deficits spending by the government is not stimulating the economy because it is not being spent and it is not being invested in a way that will create new jobs.

Probably too little too late. I'm starting to wonder whether monetary policy is really able to deal with the type of problem that we are starting to see in economies in Asia and now the US, these bubbles, and bubble chains.

All this liquidity seems to just promote the sort of behavior that has caused the bubbles that end up popping in the first place.

I wonder how much can be done by one government anyway, in this worldwide economy. Wow, maybe they are finally figuring out that maybe it's not a good thing to have a whole bunch of people in the world making stuff that they can't afford to buy.

Although I do not understand why people who bought homes say in the last 10-15 years are the people the fed wants to help out now. Why don't they just say we want house prices to stay up no matter what.

Anybody in this country who is competing on a world wide level in their job will probably not see their wages go up, and many have had them go down or have had to take wages reductions in different jobs. So no, I'm not interested in having inflation right now and would like some better explanations on why deflation is such a bad thing. Or in my case, we have had our wages the same for several years, while paying more and more for health care so on a personal level, yeah I could go for some deflation on my health care costs, if you want my personal spending on other stuff to go up. My doctor makes $500 per hour going on rounds in the hospital while at the same time in this country we have people working minimum wage jobs living in homeless shelters, so yeah, I think maybe some deflation in housing may be in order, or at any rate, it would be nice to have people explain why it would be a very bad thing for poor people to afford housing and health care on the wages that the world says that they deserve to make.

Hi Northernlights:

The problem with deflation is less theoretical and more practical. Meaning that, in a perfect market, the Free Lunch crowd is right that prices would rise and fall to account for the money supply. The problem is, in the real world, there tends to be a lot of "price stickiness" - prices are to unlikely to fall. There are lots or reasons for this, including psycological factors, knowledge gaps, etc.

Some might be tempted to say "but so what? In the long run it will work out." Of course, to paraphrase the great JMK, in the long run, we're all dead.

And so the most likely outcome is that aggregate demand begins to decline. Prices are comparatively more expensive, people cut back their spending, creating less demand, jobs are cut, people spend less because they fear unemployment, aggregate demand falls again, etc. - possibly leading to the kind of downward spiral in which Japan finds herself.

This is a very serious problem. Particularly if you couple it with a fiscal policy like ours. As Bakho pointed out, tax cuts going to the wealthiest people tends not to increase their spending, so they don't do much good for aggregate demand. And where are they going to put their money? If the problem of lack of aggregate demand means you're unlikely to get much return by building productivity. We could end up near the libquidity trap, from which it isn't clear how we would get out.

sz

The best way to increase inflation is to increase wages. Increasing the minimum wage by $1 per hour ought to have a big effect especially because minimum wage workers spend all they make. Why don't we hear this in the mix of deflation fighting policies?

"Increasing the minimum wage by $1 per hour ought to have a big effect especially because minimum wage workers spend all they make. Why don't we hear this in the mix..."

First, there aren't many minimum wage workers, only about 5 million IIRC, out of about 135 million. Second, about half are teenagers who are members of well-off households who are likely to save their money. Third, studies show that for every 10% increase in the minimum wage, minimum wage employment goes down about 2%.

I don't think that adding to the minimum wage would do much good unless you have other programs to account for the difficulty in living circumstances of having more and more of your population working at lower wages, and I do not think it is politically possible to raise the minimum wage in this country to a level that can support a family of 4. In other words, expansion of the Earned Income Credit and some kind of programs for housing and food to account for the inflated asset prices.

But then you're going to have more and more people working at lower and lower wages and a government that says we're going to manage for 1% to 2% inflation, meaning that your wages are not going up and your ability to buy assets is going to decrease, but the government is making other people in the society, who aren't competing in the worldwide market, richer and richer. That sounds like a recipe for disaster. That's what happened to the working class in this country and the rest of us said well that's okay because that's all they are worth on the world market and if they have to live in their cars or homeless shelters on the wages they make so be it. Since Reagan, people pretty much bought into the Calvinist capitalist notion that well, if people are having tough times then it must be their own damn fault or they are not quite as worthy or smart human beings, and deserve what they get. But will the society be able to support these inflated asset prices and a population where half the workers are eligible for Earned Income Credit?

I'm not familiar with the Japan situation but maybe the people there are not thrilled with that scenario either. I am saying that you cannot have more and more of your population working at world-wide competitive wages at the third world and second world level and then have them trying to compete for assets that are inflated by government policies.