Comments on: Do we need an inflation target? http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: 10024 http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18619 Tue, 21 Sep 2010 05:19:22 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18619 Re: “So. Inflation? Yes please”

If, as you wrote in another posting on Monday, “There are serious ethical questions surrounding whether or not investors should own stock in BP,” are there not even more serious ethical questions surrounding confiscating savings?

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By: DetroitDan http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18611 Tue, 21 Sep 2010 02:12:48 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18611 I’m with Marshall Auerback. Monetary policy provides a poor tool-set in the current environment…

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By: IntoTheTardis http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18589 Mon, 20 Sep 2010 22:01:22 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18589 How soon we forget. I remember reading articles on this very website bemoaning the reckless, damn-the-consequences, gambling type behavior of the men on Wall Street that led to the current financial crisis. Everyone thought more women in the brokerage and investment houses would be a palliative to all this nutty risk taking. Now some of you guys (it’s always the guys) telling the girls to get lost. We’re just setting ourselves up for another fall.

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By: OnTheTimes http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18573 Mon, 20 Sep 2010 20:03:21 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18573 @gpowell, Do interest rates influence investment? Yes, to some extent, but my point is that reducing the cost of debt to zero will not spur investment if there are no investments that are deemed to be worthwhile. The cost of capital is only one component of a product or service; just because it becomes less expensive does not make the product or service viable.

If you were selling widgets and were selling 1 million widgets per year, and thought that you could not increase that number over the next two or three years, you would not invest in adding additional manufacturing capacity, just because the cost of capital was free. You would have additional debt to service (even if the interest rates was zero), and no additional sales.

Now if you thought you could increase sales by 30% over 3 years by adding capacity, the interest rate would be a significant factor in your decision to make that investment. But that’s the problem with the economy today, many businesses believe sales will not increase, so they do not want to invest in additional capacity. And these businesses also do not want the government to increase its spending. So, I keep asking people, if businesses don’t want to invest, and the government doesn’t invest (or even give away money), then what will be the driver for growth? Interest rates alone can not do that.

And in a normal economic climate, using interest rates to control growth can be dangerous, for when you want to slow down a growing economy (which is probably already inflationary), raising interest rates increases the cost of capital, which creates inflationary pressure on just about every product or service that is dependent on debt financing. The economy gets caught in a vicious cycle, which always ends badly.

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By: gpowell http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18553 Mon, 20 Sep 2010 18:20:11 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18553 @OntTheTimes

Your logic is completely flawed. Of course interest rates influence investment decisions since they determine both the cost of funds as well the present value of profits. They also influence consumption by determining the cost of borrowing. This is standard stuff.

And the reason monetary policy is so ineffective right now is because you can’t set interest rates less than zero, which would be required for the current situation.

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By: TFF http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18546 Mon, 20 Sep 2010 17:53:25 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18546 Inflation is tricky to manipulate because it is largely a matter of market expectations. If people expect inflation, then they will spend/invest in preference to paying down debt. If people fear deflation, then no amount of monetary stimulus will prevent them from paying down debt in preference to spending.

In theory, an inflation target should help to control expectations. If everybody has confidence that the Fed will engineer 3% inflation, then their decisions will support that target. Under the present system, the Fed is supposedly aiming for 2-2.5% inflation unless circumstances dictate otherwise, in which it might be much higher than that for a period of time. Or we might end up with deflation, if they can’t figure out how to get things moving in the right direction.

I’ve read a persuasive argument that the Fed should target MARKET EXPECTATIONS of inflation rather than the inflation rate itself. Both because those expectations tend to be self-fulfilling and because the actual inflation rate is somewhat of a lagging measure. Apologies that I can’t offer you a link on that one.

While in theory a steady and predictable inflation rate is no different from a stable currency (since inflation expectations get calculated into borrowing costs anyways), I’m inclined to prefer a 3% rate of inflation. There is always going to be some variation around the target rate (especially since individual circumstances do not necessarily track the national average), and it is psychologically difficult to adjust to FALLING wages. Easier to build in a steady creep. Moreover, there are times (such as today) when real interest rates dip into negative territory. Better to pay 0.15% interest in an environment with 2% inflation than to attempt to engineer *negative* interest rates. I don’t think it is in the public interest to have people hoarding cash under their mattress rather than using banks.

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By: OnTheTimes http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18541 Mon, 20 Sep 2010 17:16:28 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18541 @gpowell, if we have inflation, there will be higher interest rates, and no guarantee managers will decide to invest in their business. If they don’t believe the economy is growing, they will just put their cash in higher interest earning accounts, which do not necessarily yield growth in jobs and individual income.

The idea that monetary policy (i.e., controlling interest rates) can be used to achieve economic growth has a giant flaw: most US-trained managers will not increase investment if they believe the economy is flat or shrinking, regardless of how cheap money is (that is what is happening now). People don’t invest just because rates are low, they need to believe that they can earn a profit. Conversely, increasing interest rates is often not enough to prevent a bubble – if the potential profits are great enough (like in hevily leveraged speculation), increasing interest rates a point or two will not deflate a bubble.

Monetary and financial policies are factors that affect investment decisions, not drivers.

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By: gpowell http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18537 Mon, 20 Sep 2010 16:17:44 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18537 @OnTheTimes,

The biggest penalty for cash hoarders is inflation. Why would anyone not use monetary policy, as well as fiscal policy, to achieve economic growth?

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By: gpowell http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18536 Mon, 20 Sep 2010 16:15:12 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18536 Part of the problem is that the “acceptable” rate of inflation has progressively been defined downward. A rate of over 10% from 1980 certainly seems excessive, but now 3% is deemed “high”. Plus, a good case can be made that the 3% figure is consistent, maybe even necessary, for a healthy economy. And as has been pointed out, a brief burst above the level would be good to help indebted consumers deleverage.

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By: OnTheTimes http://blogs.reuters.com/felix-salmon/2010/09/20/do-we-need-an-inflation-target/comment-page-1/#comment-18533 Mon, 20 Sep 2010 16:05:51 +0000 http://blogs.reuters.com/felix-salmon/?p=5414#comment-18533 Inflation != economic growth, and we need economic growth, so we shouldn’t be setting a target for any kind of inflation. We should be setting a target for a specific growth level (one that is sustainable over the long term and does not introduce transients in the short term). If there is growth, there will be inflation, but trying to achieve or control growth by controlling inflation is like trying to control the speed of the car by listening to the sounds that come through the window. It isn’t going to be all engine or wind noise.

The only way to insure continued growth is to strongly encourage cash hoarders to stop hoarding cash and invest it. Right now cash hoards are at an all-time high, because there is little incentive to invest, and no penalties for hoarding. Growth can be achieved (and controlled better than by manipulating the money supply and interest rates) by adjusting penalties for hoarding and incentives for investing. Inflation should be a side effect of growth, not the driver for it.

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