Greg Ip

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Economics focus

Put out

Uncertainty over the size of the output gap complicates the task of central banks

HAVING raised the alarm on deflation, the Federal Reserve has now begun to sound the all clear. The statement it released after its policy meeting on June 24th notably omitted the warning from its three prior meetings that “inflation could persist for a time below rates that best foster economic growth and price stability”. To be sure, with the economy gradually finding a bottom and the rate of decline in home prices slowing, the chances of a downward spiral of deflation and economic activity have diminished. Yet it seems premature to write off the threat as long as a large output gap persists. Read the rest of this entry »

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Employees are proving stoical in the face of pay cuts and compulsory unpaid leave

Illustration by David Simonds

BACK when times were better and the newspaper industry wasn’t fighting for dear life, reporters at the Cleveland Plain Dealer would regularly grumble at the measly pay increases their union negotiated. Last month, when the union announced it had negotiated a 12% pay cut in exchange for a promise of no lay-offs, there was applause. “It took me aback,” says Harlan Spector, a medical reporter and one of the negotiators.

Like many long-standing economic relationships, “wage stickiness” is being tested by the savagery of the recession. Read the rest of this entry »

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Inflation is bad, but deflation is worse

MERLE HAZARD, an unusually satirical country and western crooner, has captured monetary confusion better than anyone else. “Inflation or deflation,” he warbles, “tell me if you can: will we become Zimbabwe or will we be Japan?”

How do you guard against both the deflationary forces of America’s worst recession since the 1930s and the vigorous response of the Federal Reserve, which has in effect cut interest rates to zero and rapidly expanded its balance-sheet? Read the rest of this entry »

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The simple rules by which central banks lived have crumbled. A messier, more political future awaits

Illustration by Derek Bacon

IN THE world that existed before the financial crisis, central bankers were triumphant. They had defeated inflation and tamed the business cycle. And they had developed a powerful intellectual consensus on how to do their job, summarised recently by David Blanchflower, a member of the Bank of England’s monetary policy committee, as “one tool, one target”. The tool was the short-term interest rate, the target was price stability.

This minimalist formula fitted the laissez-faire temper of the times. A growing array of financial markets could price risk and allocate credit efficiently. Central bankers had merely to calibrate their interest-rate tools and all other markets would automatically adjust. Central banks still cared about financial stability and full employment, but could argue these were best served by stabilising prices—without, if you please, interference from politicians.

The financial crisis has upended all that. Read the rest of this entry »

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Mar 19th 2009
From The Economist print edition
Today’s fattened central-bank balance-sheets evoke fears of inflation. Deflation is the bigger worry

BACK in 2002 Ben Bernanke, then still a Federal Reserve governor, declared that “under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” That does not mean it is easy.

On March 18th America’s inflation rate was reported at 0.2%, year on year, in February. The same day the Fed said “inflation could persist for a time” at uncomfortably low levels. Yet some economists and investors insist high inflation, even hyperinflation, is lurking in the wings. They have two sources of concern. The first is motive: the world is deleveraging, ie, trying to reduce the ratio of its debts to income. Policymakers might secretly prefer to do that through higher inflation, which lifts nominal incomes, than through the painful processes of cutting spending and retiring debt, or default. The second is captured by the Fed’s announcement that it plans to purchase $300 billion in Treasury bonds and an additional $850 billion of mortgage-related debt, bringing such purchases to $1.75 trillion in total, all paid for by printing money. It is not alone: around the world, central-bank balance-sheets have ballooned (see chart).

This is scary stuff to those who swear by Milton Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon.” But the role of the money supply in creating inflation is less obvious than monetarism suggests.

The quantity theory of money holds that the money supply, multiplied by the rate at which it circulates (called velocity), equals nominal income. Nominal income in turn is the product of real output and prices. But does money supply directly boost nominal income, or does nominal income affect velocity and the demand for money? The mechanism is murky. Read the rest of this entry »

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The Fed finds innovative ways to pump hundreds of billions of additional dollars into the economy

AFP

A FEW days ago Ben Bernanke, chairman of the Federal Reserve, was asked to identify the biggest obstacle to economic recovery. That “we don’t have the political will,” he replied.

Mr Bernanke showed his own will on Wednesday March 18th, when the Fed’s policy panel said it would purchase $300 billion in Treasury debt, mostly maturing in two to ten years, starting next week. Read the rest of this entry »

Feb 12th 2009 | WASHINGTON, DC
From The Economist print edition

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Today’s crisis has given new relevance to the ideas of another great economist of the Depression era

Sue Vago

SHORTLY after he was elected president, Barack Obama sounded a warning: “We are facing an economic crisis of historic proportions…We now risk falling into a deflationary spiral that could increase our massive debt even further.” The address evoked not just the horror of the Depression, but one of the era’s most important thinkers: Irving Fisher.

Though once America’s most famous economist, Fisher is now almost forgotten by the public. If he is remembered, it is usually for perhaps the worst stockmarket call in history. In October 1929 he declared that stocks had reached a “permanently high plateau”. Today it is John Maynard Keynes, his British contemporary, who is cited, debated and followed. Yet Fisher laid the foundation for much of modern monetary economics; Keynes called Fisher the “great-grandparent” of his own theories on how monetary forces influenced the real economy. (They first met in London in 1912 and reportedly got along well.)

As parallels to the 1930s multiply, Fisher is relevant again. Read the rest of this entry »