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Crackpot conspiracy theory? The Fed doesn't think so [1]. As that FAQ explains, the FOMC judges that maintaining a 2% inflation rate is optimal for price stabil

by reedlaw 13y ago

Crackpot conspiracy theory? The Fed doesn't think so [1]. As that FAQ explains, the FOMC judges that maintaining a 2% inflation rate is optimal for price stability and maximal employment. The federal government operates at a deficit [2]. The Federal Reserve Banks holds U.S. Treasury debt as collateral for the Federal Reserve notes put into circulation by the Fed [3]. Therefore, although the quoted statement is somewhat inaccurate, the essential idea that government policy is responsible for inflation and finances its operations is true. 1. http://www.federalreserve.gov/faqs/economy_14400.htm http://www.federalreserve.gov/faqs/economy_14400.htm 2. https://www.cbo.gov/publication/21999 https://www.cbo.gov/publication/21999 3. http://www.federalreserve.gov/faqs/currency_12770.htm http://www.federalreserve.gov/faqs/currency_12770.htm

a_c_s 13y ago
Low, positive inflation is the ideal for many reasons that have nothing to do with the federal budget: inflation encourages investment, spending, makes people feel richer when their salaries go up every year, and it reduces debts. Given that most americans carry some form of large debt (student loans, mortgages, etc.), this is good for most citizens.
nhaehnle 13y ago
We are talking about slightly different things. I responded to the claim that inflation is created with the goal of financing a government deficit, and I stand by the claim that that's crackpot conspiracy theory. To substantiate that claim, you would have to prove somehow that the real interest rate is lower than it would be without this inflation.
- reedlaw 13y ago
  While I wouldn't defend the wording of the original post, I don't believe it's too far from the truth. What do you mean by the _real_ interest rate? While Fed Chairman Ben Bernanke claims the Fed is simply "managing the monetary base" [1], the Fed does in fact purchase US Treasury Bonds without requiring the Treasury to pay back the debt. This monetization of debt allows the Treasury to increase government spending. The outcome is an increase in the monetary base which leads to rising price levels, or inflation. So while saying that inflation is created with the goal of financing government deficit is somewhat backwards, it's only a conflation of cause and effect--not a "crackpot conspiracy theory". 1. http://research.stlouisfed.org/publications/es/article/9644 http://research.stlouisfed.org/publications/es/article/9644
  - nhaehnle 13y ago
    By the real interest rate I mean the interest rate after taking inflation into account. If you think about it, the average long term nominal interest rate in the economy is going to be roughly in line with nominal growth of GDP, because there are market mechanisms in place to make it so: If the nominal interest rate exceeds nominal growth in GDP, then wealth effects (aka people have more money thanks to interest and therefore spend more) will eventually encourage faster growth of nominal GDP - either by stimulating more production (real GDP growth) or by driving up prices (inflation), or, more likely, by a mix of both. If nominal interest rates are below nominal growth in GDP, then it becomes more profitable to borrow money to invest in production. People will do this, and this will adjust interest rates up (you can understand this from two directions: on the one hand, profit is being spread around via interest, on the other hand, demand for loan drives up interest rates). These adjustments do not take over night - they probably operate on the timescale of years (unfortunately, economics tends to pay very little attention to how fast such market mechanisms operate, so we basically have no scientific basis for such statements, just common sense and gut feelings). Still, you cannot escape those adjustments of the interest rate in the long term. What does this have to do with governments, inflation, and financing the deficit? If the government consciously acted to increase inflation to finance its deficit [1] this would indeed temporarily benefit borrowers. However, this is a temporary measure and certainly not the case today. Furthermore, governments have also consciously acted to decrease inflation, which obviously has the opposite effect. So in the end, it's at best a wash. One last point: the Fed does in fact purchase US Treasury Bonds without requiring the Treasury to pay back the debt The same happens in the real economy as well. Firms operate using debt that is effectively never paid back. The debt is regularly rolled over, sure, but it is de facto permanent and contributes to a permanent increase of the money supply, which is what matters (if any of those quantities matter). The Fed does buy mostly Treasuries to create the monetary base (which is necessary for purely technical reasons), but what else would you have them buy? I personally wouldn't want "my" central bank to gamble on risky assets. [1] Also, I find it fascinating that the goldbugs never point to actual examples where this happened. I suspect they don't because it's a myth, at least in the countries those people come from outside of wartime.

by reedlaw 13y ago

a_c_s 13y ago

Low, positive inflation is the ideal for many reasons that have nothing to do with the federal budget: inflation encourages investment, spending, makes people feel richer when their salaries go up every year, and it reduces debts. Given that most americans carry some form of large debt (student loans, mortgages, etc.), this is good for most citizens.

nhaehnle 13y ago

We are talking about slightly different things. I responded to the claim that inflation is created with the goal of financing a government deficit, and I stand by the claim that that's crackpot conspiracy theory. To substantiate that claim, you would have to prove somehow that the real interest rate is lower than it would be without this inflation.

reedlaw 13y ago
While I wouldn't defend the wording of the original post, I don't believe it's too far from the truth. What do you mean by the _real_ interest rate? While Fed Chairman Ben Bernanke claims the Fed is simply "managing the monetary base" [1], the Fed does in fact purchase US Treasury Bonds without requiring the Treasury to pay back the debt. This monetization of debt allows the Treasury to increase government spending. The outcome is an increase in the monetary base which leads to rising price levels, or inflation. So while saying that inflation is created with the goal of financing government deficit is somewhat backwards, it's only a conflation of cause and effect--not a "crackpot conspiracy theory". 1. http://research.stlouisfed.org/publications/es/article/9644 http://research.stlouisfed.org/publications/es/article/9644
- nhaehnle 13y ago
  By the real interest rate I mean the interest rate after taking inflation into account. If you think about it, the average long term nominal interest rate in the economy is going to be roughly in line with nominal growth of GDP, because there are market mechanisms in place to make it so: If the nominal interest rate exceeds nominal growth in GDP, then wealth effects (aka people have more money thanks to interest and therefore spend more) will eventually encourage faster growth of nominal GDP - either by stimulating more production (real GDP growth) or by driving up prices (inflation), or, more likely, by a mix of both. If nominal interest rates are below nominal growth in GDP, then it becomes more profitable to borrow money to invest in production. People will do this, and this will adjust interest rates up (you can understand this from two directions: on the one hand, profit is being spread around via interest, on the other hand, demand for loan drives up interest rates). These adjustments do not take over night - they probably operate on the timescale of years (unfortunately, economics tends to pay very little attention to how fast such market mechanisms operate, so we basically have no scientific basis for such statements, just common sense and gut feelings). Still, you cannot escape those adjustments of the interest rate in the long term. What does this have to do with governments, inflation, and financing the deficit? If the government consciously acted to increase inflation to finance its deficit [1] this would indeed temporarily benefit borrowers. However, this is a temporary measure and certainly not the case today. Furthermore, governments have also consciously acted to decrease inflation, which obviously has the opposite effect. So in the end, it's at best a wash. One last point: the Fed does in fact purchase US Treasury Bonds without requiring the Treasury to pay back the debt The same happens in the real economy as well. Firms operate using debt that is effectively never paid back. The debt is regularly rolled over, sure, but it is de facto permanent and contributes to a permanent increase of the money supply, which is what matters (if any of those quantities matter). The Fed does buy mostly Treasuries to create the monetary base (which is necessary for purely technical reasons), but what else would you have them buy? I personally wouldn't want "my" central bank to gamble on risky assets. [1] Also, I find it fascinating that the goldbugs never point to actual examples where this happened. I suspect they don't because it's a myth, at least in the countries those people come from outside of wartime.