Mend the Fed

 

            The banks deserve much of the blame for the messy state of our economy, and so it’s no surprise that we’ve directed much of our anger at them and what they represent. We want to regulate them so they can’t screw us again, and if that feels like punishment to them, so much the better. But as far as getting unscrewed goes, we should be focused on the Federal Reserve. The Fed has the power to get the economy back on track, and moreover, it is legally mandated to do so.

 

What Doesn’t Matter About the Fed: The Gold Standard

            A proposal formerly harbored only by conspiracy theorists has re-surfaced on the right-wing. “Paper money is worthless,” they say, “bring back the gold standard.” I get the impulse behind it. It replaces the technical and inscrutable operations of a powerful institution with a fixed reference point—a dollar would be worth some quantity of gold.

            The problem is, the value of gold moves up when there’s more demand for jewelry or fancy speaker wires, and down when we discover a big cache of it in the ground. When a bank is in trouble, nobody can provide the temporary extra dollars to protect people’s savings. Just about the only thing economists, from the left to the right, agree on is that getting off the gold standard in 1934 stopped a deflationary spiral and set off an immediate, sharp, and substantial recovery during the Great Depression. (Of course, businessmen of the era screamed that it would be the end of everything).

            A constant in American history is that the populists, the farmers, the debtors, the people, all wanted off the gold standard. If they didn’t understand the more complicated mechanics of central banking, they knew that “easier money” in hard times would make their lives better. The Fed could expend its resources scrambling to maintain an arbitrary link to some chunk of shiny metal, with no regard to the economic pain it inflicts, or it could fulfill its legally mandated purpose: stable inflation and low unemployment. Instead, we have the opposite: too-low inflation and painfully-high unemployment.

 

What Does Matter About the Fed: Targeting Growth

            Rather than focus on the technical details of real and nominal interest rates and GDP, let’s try something more intuitive: every dollar you spend adds to somebody else’s income. Right now, everyone is hesitant to spend, waiting for things to pick back up, which won’t happen unless we all start spending. The Fed can fix our coordination problem. By making us expect higher spending and incomes in the near future, we become more willing to spend today. Economic activity is good, we want more of it, and higher inflation is how we get it.

 

Inflation is Not a Dirty Word

            At the slightest hint of government action to set the economy right, “respectable” mainstream voices shriek “inflation!” as if it were some untamable beast we dare not set loose. They’ve been doing this for ages, and so far they’ve been very wrong. Wrong because significant inflation hasn’t happened since the crisis, and wrong because we’d be much better off if it did.

            Inflation is nothing more than the change in prices over time for things like food, energy, housing, and labor. If inflation is negative, too high, or unpredictable, nasty things happen. If prices are going down (deflation), and I’ve got some dollar bills, I’ll keep them under my mattress since, by this time next year, I’ll be able to buy more stuff with it. Lending breaks down for the same reason. This is a rational thing for me to do, but when it in turn reduces the incomes of all the people I would’ve bought things from, and they spend less too, eventually my income drops and I want to spend even less, and a downward spiral can ensue.

            If I thought inflation was going to go up, I’d spend now while I could buy more stuff with my money. This increase in spending can help all of us, but it’s also important to keep inflation from getting out of hand. When too many dollars are chasing goods faster than we can produce more of them, this can drive prices up, making me want to spend even sooner, and in this scenario, inflation can get unpredictable, investment gets risky, and people can’t afford the rates banks are willing to lend at. However, when we have the capacity to easily produce more things than we’re currently producing (i.e., we still have the factories and workers to produce as much stuff as we did in 2007), spending and incomes can rise for a while and help push us back on track. Nearly all deflation is bad. Some inflation is good, and as long as the Fed can convince us they will keep inflation stable, there’s no upward spiral. 

 

Higher Inflation Means Less Debt and More Demand

It’s a bit counterintuitive, that having prices go up will make you better off. But with controlled higher inflation, people tend to spend more, and our wages and our homes prices also go up. Our debt, based on the price of what we bought back when we bought it, does not. Right now, too many of us have too much debt. Instead of buying things we need (replacing your dying car, upgrading your slow internet connection), we spend too much paying down our debt. When inflation goes up, the real value of my debt drops, meaning the $100 I spend on a monthly loan payment is worth less. 

Housing prices start going back up, helping people whose mortgage debts are larger than the value of their homes. These folks don’t have to default, can once again build wealth, and will feel able to spend on their other needs, or more easily move out of town for better job prospects. Being less indebted is the same as being wealthier, and higher wealth makes people feel more comfortable spending. When a smaller fraction of your income goes to debt payments, more can be spent on actual things, and since every dollar spent adds to somebody’s income, they can spend too.

Employment also gets a boost. Right now, corporate profits have hit an all-time high, but these piles of cash haven’t helped the economy because businesses would rather wait until the economy was stronger and more stable to invest in new workers and new projects (of course, every dollar they don’t spend…). Higher inflation makes sitting on money expensive, and as the value of the money erodes, corporations realize they’re better off putting it to use. Meanwhile, when more products are being purchased, and products’ prices go up more than workers’ wages do, profits go up. Additional workers can be hired, since they add more to a business’s revenue than they cost to employ. This increases the pool of people who have money to spend, and further hiring can eventually push wages higher.

The debtor’s gain is the lender’s loss. Normally, money paid back to a bank would also end up back in the economy as a loan to somebody else. But banks aren’t doing a lot of lending these days, preferring to wait until the economy is stronger (there’s a pattern here) and so the gain that inflation would provide to us far exceeds the loss to them. Inflation slows the transfer of wealth from us to them. It’s money that we need, and that we’ll use. They don’t need it, and they won’t use it. If you were a disingenuous hack, you could call that class war. But it’s just economics.

 

Good for Today, Good for the Future

A promise to catch prices back up to where they were headed pre-crisis would help now, and a higher inflation target would be good for the future. First, higher inflation means the Fed rate can be that much higher during normal times without harming the economy. This would give the Fed more room to use its simplest and most effective tool—lowering interest rates—to put the economy back on track during normal downswings. More fundamentally, the past three decades of strategically pushing inflation lower and lower has been achieved on the backs of workers and contributed to wage stagnation. This strategy, called “opportunistic disinflation,” created the unusually slow or “jobless” recoveries we’ve come to expect, in which growth and hiring were slowed before an increased demand for workers could increase bargaining power and push wages up.

 

If Only the Chairman Had Courage

The Fed can normally stimulate the economy by lowering it’s interest rate target, but this rate has already been taken down to zero. Still, they could instead use “unconventional measures,” to achieve an inflation target or an economic growth rate target (nominal GDP-targeting). Fed Chairman Ben Bernanke, an expert on economic collapses, half-joked that if need be, the Fed could throw cash out of helicopters until people started spending and economic activity picked back up. So why is the Fed so timid?

The Fed cares about its credibility. When people believe the Fed can and will do what it says, the market anticipates that outcome and makes it that much easier for the Fed to hit its goal. Right now, they target keeping inflation under 2%, partly because they think that’s a good rate, but partly because they have earned their credibility on bringing down too-high inflation in the early 80s, and don’t want to lose that status. This is perverse: in order to preserve the cred they think they need to take action to save the economy, they are refusing to take action to save the economy.

The misguided “End the Fed” crowd and those insisting that the Fed do nothing aren’t helping either. The public’s negative perception of inflation, and the complexity of what the Fed does, makes the battle an uphill one. It also doesn’t help that a few of the conservative Board members have such an unhinged and zealous aversion to the idea of inflation that they see it around every corner and callously denounce the slightest hint of it no matter the human cost.

 

Occupy (Encourage?) The Fed

Not only is the Fed powerful and capable, but it’s also led by a man who believes the Fed can help. We need to provide a voice and a counterweight to the wrongheaded “do nothing” crowd. That doesn’t require us to sketch out the intricacies of how the macroeconomy works or change how the word “inflation” makes people feel. It requires us to understand that the Fed can do something and to demand that it do so. It requires that we be loud, impassioned, and insistent until it stops being easy to ignore the economic struggles of the 99%.

If inflation were running a few percentage points too high, public outrage and media scorn would have the Fed doing everything in its power to remedy an unpleasant financial situation. The Fed has a clear legal and moral obligation to react even more strongly to the tragic human costs of unemployment. On behalf of the 14+ million unemployed Americans, we need to scream until we’re damn sure Bernanke has heard us.

 

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