Tuesday, July 27, 2010

Bring Back Inflation

"The issue, system-wide, is that there’s a huge amount of demand for cash and other very safe, very liquid instruments. As a result of this cash shortage, there’s a glut of nearly everything else and that’s leaving many potentially productive resources idle. The Federal Reserve could almost certainly solve this by pushing up inflation expectations which would reduce the demand for cash and therefore increase the demand for things that aren’t cash. But its leadership doesn’t seem to want to do this, perhaps because it’s still pursuing a strategy of opportunistic disinflation."
The Fed has not been pursuing easy money. They've given banks more money to shore them up, but it hasn't entered the system to answer the demand for cash. It's still a tighter-than-necessary monetary policy. Bring back low level inflation.

Why? Because it's good for the economy and easy, via Sumner: "rumors the Fed would eliminate IOR [interest on reserves] triggered a big stock market rally the day before. ... If the stock market thinks a Fed action is very bullish, and rises sharply in response, that market reaction can trigger more investment even if based on an erroneous theory of monetary economics."

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