Question for economics gurus

[SpencerH]

So I'm on my way back from the gym and listening to Glenn Beck for the 10 min or so (music stations here suck).

The topic is inflation and he noted that in the 70's that the fed raised the interest rate to 20% in order to counter the inflationary effects of a 13% increase in the money supply.

He also stated that the current fed has increased the money supply by 120% over the last year in order to stabilize the banks etc. His concern is that if that money doesnt get sucked back in by the fed that it will lead to staggering inflation and/or crippling interest rates.

So what do y'all think? Yes, no, maybe, or total bull****?

[Japher]

Reaganomics... Control inflation by reducing the money supply.

IMO, supply-side economics relies on a stable economy, or at least one with a lot less problems. Without a stimulus somewhere it won't really matter what is done.

Though I'm no economic guru and could be completely wrong.

[loinburger]

Books on tape

[Japher]

Books on Tape will now be called "Books"

and

What we currently refer to as books will now be called "Books on paper"

[snoopy369]

It's Glenn Beck. Pretty much guarantees 'total bull****'.

From what I've seen, inflation isn't a significant concern right now. In fact, lack of money supply is a big part of the problem right now... increasing the money supply is one of the ways they've increased the availability of credit.

The Greenspan Fed was pretty good at controlling inflation. I don't know much about the current Fed's differences from Greenspan, but I think they have a pretty good idea of what needs to be done to control inflation.

I also don't for a second believe a 120% increase in any particular money supply (there are several). The M-2 money supply is around $8 trillion, and increasing it by 120% would be somewhat insane. (See http://en.wikipedia.org/wiki/File:Co...ey_supply2.svg for an example graph, current as of july 2009.)

[KrazyHorse]

Japher, that's always how the fed controls inflation. They manipulate interest rates, which changes the money supply

Spencer, the reason that the fed has increased the money supply so much is that the banks (and others) have deleveraged greatly over the past little while, while monetary velocity dropped like a rock. As those conditions begin to reverse themselves the fed will increase interest rates, decreasing the money supply and attempting to maintain the US on a relatively stable inflation path. This problem is what's become referred to as the fed's "exit strategy". Luckily, the fed has all the tools it needs to do this in a relatively responsive way. I wouldn't be surprised if they under- or over-shoot slightly, due to the scale of the disruption, but in general it will be handled quietly and effectively.

The real problem in the 70s was that there was such high inflation for so long that inflation EXPECTATIONS had gone way up. People expected prices to increase, so they increased their own prices. To reverse these expectations, the Fed had to take drastic steps. Inflation expectations are nowhere near where they were. In fact, the US is still teetering on the brink of deflation.

This brings up the idea of one reason why deflation is a more troubling effect than inflation; there is a lower bound to interest rates, namely 0% (if you attempt to reduce it below that people simply move into cash, which returns 0%). The fed is impotent, using standard open market operations, to counter deflation when interest rates are at 0%. There is no such problem on the upside.

EDIT: meant "interest", had written "inflation"

[KrazyHorse]

snoopy, the question of "what money supply" is indeed important. Banks deleveraging reduce the multiple M2/M0

M0 might well have increased by 120% (I don't even know if they still publish M0 statistics; M1 and M2 are much more widely used measures). This is a simple statement about banks deleveraging, topping off their reserves etc. It simply doesn't matter that much.

EDIT: yep, it's M0

[MRT144]

Japher, that's always how the fed controls inflation. They manipulate interest rates, which changes the money supply

Spencer, the reason that the fed has increased the money supply so much is that the banks (and others) have deleveraged greatly over the past little while, while monetary velocity dropped like a rock. As those conditions begin to reverse themselves the fed will increase interest rates, decreasing the money supply and attempting to maintain the US on a relatively stable inflation path. This problem is what's become referred to as the fed's "exit strategy". Luckily, the fed has all the tools it needs to do this in a relatively responsive way. I wouldn't be surprised if they under- or over-shoot slightly, due to the scale of the disruption, but in general it will be handled quietly and effectively.

The real problem in the 70s was that there was such high inflation for so long that inflation EXPECTATIONS had gone way up. People expected prices to increase, so they increased their own prices. To reverse these expectations, the Fed had to take drastic steps. Inflation expectations are nowhere near where they were. In fact, the US is still teetering on the brink of deflation.

This brings up the idea of one reason why deflation is a more troubling effect than inflation; there is a lower bound to interest rates, namely 0% (if you attempt to reduce it below that people simply move into cash, which returns 0%). The fed is impotent, using standard open market operations, to counter deflation when inflation rates are at 0%. There is no such problem on the upside.

Right on the money, no pun intended. You can increase money supply all you want but if it isn't going anywhere, so what?

[KrazyHorse]

Meanwhile, M1 has only increased by ~15% and M2 by ~6%

The point is that the restrictive measures of the money supply are meaningless for inflation.

[KrazyHorse]

Right on the money, no pun intended. You can increase money supply all you want but if it isn't going anywhere, so what?

Actually, changes in monetary velocity (defined for money supply M2, as it usually is) are much less important than is the ratio M2/M0 (leverage of banks)

The former changes appreciably during dislocations, but not as dramatically as leverage.

[SpencerH]

Spencer, the reason that the fed has increased the money supply so much is that the banks (and others) have deleveraged greatly over the past little while, while monetary velocity dropped like a rock. As those conditions begin to reverse themselves the fed will increase interest rates, decreasing the money supply and attempting to maintain the US on a relatively stable inflation path. This problem is what's become referred to as the fed's "exit strategy". Luckily, the fed has all the tools it needs to do this in a relatively responsive way. I wouldn't be surprised if they under- or over-shoot slightly, due to the scale of the disruption, but in general it will be handled quietly and effectively.

The real problem in the 70s was that there was such high inflation for so long that inflation EXPECTATIONS had gone way up. People expected prices to increase, so they increased their own prices. To reverse these expectations, the Fed had to take drastic steps. Inflation expectations are nowhere near where they were. In fact, the US is still teetering on the brink of deflation.

This brings up the idea of one reason why deflation is a more troubling effect than inflation; there is a lower bound to interest rates, namely 0% (if you attempt to reduce it below that people simply move into cash, which returns 0%). The fed is impotent, using standard open market operations, to counter deflation when inflation rates are at 0%. There is no such problem on the upside.

While not knowing what they are, I accept your statement that " the fed has the has all the tools it needs to do this in a relatively responsive way". I just wonder whether the feds ability to reduce the money supply in a reasonable fashion takes into account the inflationary pressures due to the prospects for massive deficit spending.

[DanS]

I would add to KH's post that the Fed has zero practice in removing this magnitude of stimulation. In theory, there's nothing to it. But in reality, the Fed could fvck it up so that we have deflation or inflation. To guard against a possible fvckup into continued deflation, the Fed might accept a few years of elevated inflation.

[KrazyHorse]

The inflationary pressure due to deficit spending are easily countered by the Fed.

Unfortunately, this is the "bad equilibrium"; the gov't spends too much money and the Fed restricts non-gov't spending to maintain the economy at capacity.

[KrazyHorse]

I would add to KH's post that the Fed has zero practice in removing this magnitude of stimulation. In theory, there's nothing to it. But in reality, the Fed could fvck it up so that we have deflation or inflation. To guard against a possible fvckup into continued deflation, the Fed might accept a few years of elevated inflation.

Dan, the upslope generally tends to be gentler than the downslope. I agree that they will err toward inflation, and that's fine with me. In fact, it should be their stated policy (targeting price path rather than instantaneous inflation rate)

[MRT144]

Actually, changes in monetary velocity (defined for money supply M2, as it usually is) are much less important than is the ratio M2/M0 (leverage of banks)

The former changes appreciably during dislocations, but not as dramatically as leverage.

But the shrieking about money supply is all about money supply without regard to anything but money supply. Money supply.