Sunday, September 25, 2011

TBA reading for 9.30 - and some Barbara Streisand

To prepare for the library day, read my previous post, which presents a version of an informative argument. Also read Krugman and Sumner, which both do the same.

It occurs to me that one way of understanding what the Fed usually does, and what it is failing to do, is through this song:

Ordinarily changes in economic conditions are marginal. In a case when there's a slight increase in the desire to hold money, or money-like assets (such as short term, safe debt), the Fed move to lower or raise interest rates makes it a bit cheaper to get money, and that counteracts the sudden desire to be slightly more liquid, that is, to want a bit more liquid assets like money or things easily convertible into money. But it also says, in effect, "Hey, why did we change like this? Let's go back to the way we were. It was better." People notice that the Fed's actions are probably sufficient to return things to the way they were. So they start acting in the way they used to act. The Fed implicitly set a goal for its policy, and everyone got the message and acted.

What's happening now is that there was a large increase in the desire for liquidity which has not really changed. When the Fed says it wants to raise or lower longer term interest rates a bit, it is saying that it wants to lower that desire for liquidity a bit. But the desire for liquidity did not increase a bit--it increased a whole helluva lot. So to return things to the way they were, it's necessary for the Fed to do something that effectively signals that their goal is to return things to the way they were. Everyone sees the Fed as the bulwark against inflation. A bit of inflation--the good kind that raises wages and thus reduces debt burdens, increasing real income--would have to happen in the short run for the economy to recover, as some of the increase in demand will show up in the form of higher prices. So the Fed should say that they will allow some higher than average inflation as part of a period of higher than average economic growth. Not only is that good because it would help raise real income, but it would also be a signal to the general population that the Fed is thinking about the way we were and growing nostalgic.

Update: OK, just one more. You won't regret it as it's really short. Read here about the Trillion dollar coin idea, and click on the first embedded link for a discussion of its legality.

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