Inflation And Interest Rates

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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That the Great Moderation has ended is now cliché. It had followed the Great Inflation whose specter threatens to rise from the dead like a bad movie sequel. To the detriment of the far too technically inclined economics profession that tends to see the economics of the family as a tradable on Craig’s List unless those caught in its web succumb to a dysfunctional professional culture of Keynes and Hayek, it would be useful first to explain the Cirque du Soleil of the technocratic glitterati whose unelected work to influence the economies of nations, much like China’s secretive bureaucratic governance of its country, is barely comprehensible to the average citizen while being extraordinarily palpable.

The Great Moderation meant that prices in the United States and elsewhere in the developed world did not rise. Their rise had slowed down to a trickle of about 2 to 3 per cent per year for about a decade, since the mid-‘90s eve as the largely paper wealth of Americans rose substantially only to collapse gradually beginning 2000 through now.

This prolonged moderation in inflation (or the Great Moderation) had come because the large developing countries such as China (primarily), India, Mexico, Brazil (and other Latin American countries), Russia and South Africa were making cheap goods for American consumption and sending their savings into New York and London, making the financial asset values rise. The dollar was strong and economic growth stable, dampening the jiggles in the charts (also known as volatility).

Americans borrowed against the rising paper wealth to spend domestically increasing domestic consumption. Imports trended ever higher relative to exports. Investment rose in the burgeoning information technology sector unguided by any coherent vision only to end in the collapse of the tech bubble in 2000, corporate corruption (which the economics profession likes to politely call corporate governance), an infrastructure overhang and the ultimate dissolution of the America Online-Time Warner merger.

All along the wages of both economists and financiers rose in a manner so as not to fall when the economy declines as it does for most other ordinary Americans, making them stakeholders in the complicity. A small interest group of professional economists that began in the United States mostly after World War II out of Massachusetts Institute of Technology (MIT), Harvard University and University of Chicago to provide cost estimates for government projects, today dominates both the academia and Washington out of the shadows of elected officials, taking credit when times are good and blaming the politicians and politics when times are bad and pleading ignorance about how the economy works.

The Great Inflation, however, after the twin energy shocks that had spread over the decade of the ‘70s, was ended by the behavior of economic policy makers with some integrity who stood to take the credit and the blame for the economic times they were in, genuinely seeking solutions to economic problems, counseling elected representatives risking their own careers. Its potential return also, not very surprisingly, coincides with the loss of integrity in the economics profession that had begun by making geniuses out of average government bureaucrats, academics and day-to-day Wall Street traders since 1987 after Alan Greenspan had taken over the Federal Reserve from Paul Volcker. Not even the hard sciences have so many star professors commanding six figure salaries as economics does.

This sham of marketing the economics and finance professions in the media and government has also introduced a bigger threat to decent behavior (or the compromise of moral conduct to supposedly achieve a bigger purpose): to raise the standard of living of Americans (income distribution issues aside) at the expense of the rest of the world. The Great Moderation was a consequence of such moral hazard. Access to markets and money speak louder than the conduct of foreign governments toward their own people, because, the economic logic goes, dysfunction elsewhere would be better to divert those resources to support the American way of life. So, it is perpetuated by coopting the elites everywhere.

And now to mitigate the return of the Great Inflation after the foreigners have revealed their aspirations for a better life, inflation is being exported at the expense of domestic employment. The return of the higher borrowing costs over the long term in U.S dollars and other major world currencies are being sent to the developing countries through foreign investment, for prices elsewhere to rise and not in the United States so that the Federal Reserve can say it is doing its job.

This decline in domestic investment is costing Americans jobs and the jobless are being put on the social safety net. The government thinks that America is wealthy enough to get away with it until the large developing countries and the domestic American boomer retirements are all done, by mid-century, for investment to rise later, with little concern for values in geopolitics in the policies dictated by the pseudo-science of economics. Keynes is for the expanding government and Hayek for the expanding markets, for both to coexist.

Any dissent against this pre-fabricated agenda is crushed mercilessly. Those who wish to survive the ideology in the developed world must either work for the government or the financial markets over at least the next two decades, with little regard to the rest of the stagnating social fabric which is manipulated by holding up scapegoats and main street patriotism. The world is heading to a mixed political economy of powerful governments and powerful markets, its future leaders bred to lead by the sparse but powerful academic institutions.

The overarching ideology is worse: it is about race and religion and the supremacy of Anglo-America over the rest of the world, forever beholding it to its service. It is a form of neocolonial economic slavery in a world of sovereign countries, seduced by the neon lights of Time Square and the unworthy glamour of all top-tier educational institutions which are all, without exception, Anglo-American. The Federal Reserve makes monetary policy in this mindset.

It is clear from the above discussion that it is not in the interest of either the Fed or the Treasury to see unemployment in the United States fall. Instead of a broader economic recovery to lower unemployment, a persistently higher level of unemployment is being deliberately targeted to keep inflation, as a consequence of persistently lower domestic investment, low. The markets are now confused when the institution will begin to raise rates and if so, how fast.

The Federal Reserve can indeed offer a simple solution to market confusion: clearly tell them how much maximum inflation it is willing to tolerate. The minimum inflation is obviously zero and any lower is detrimental to the economy akin to a depression which nobody wants and which will never happen again. Instead, the Federal Reserve is obfuscating the issue by talking about its comfort zone for inflation. It says that current inflation is within its comfort zone, which is a measurement, whatever the measure, subject to both statistical and other measurement uncertainties. So, a band of 0.5 per cent from 1.5 to 2 is hardly a band. This is not an inflation targeting range.

The markets are concerned about what the Fed would do as inflation rises above its comfort zone of 2 per cent. How much more inflation is it willing to tolerate? Will it contract monetary policy to stay as close to 2 per cent as possible? The Fed does not want to answer this question. But they must if the country is to exit from the Fed’s money supply since the crisis began in 2007 and into a robust recovery.

There are sound economic reasons why the Fed must tolerate up to 5 per cent inflation as measured by the Bureau of Labor Statistics (BLS) Consumer Price Index (CPI) measure without excluding food and energy. At the end of the Great Inflation in 1987, 5 per cent is what Alan Greenspan had inherited from Paul Volcker. Now that the gains of the Great Moderation are gone, it is a fool’s errand to export inflation all over the world at the expense of domestic investment and employment to keep domestic inflation low, as if foreign investment and domestic investment are substitutes.

If we then assume that the Fed is hypothetically willing to tolerate up to 5 per cent CPI inflation, the markets will see that they have 3 per cent room realizing that the Fed will raise rates as year-on-year inflation, year after year, approaches 5 per cent, so as not to shock the markets with sharp monetary contractions. It is in the interest of the financial markets to invest in such a manner so as not to run up inflation quickly by investing in commodities as they had done in 2006-2007 because any run up in energy and grain prices that is incommensurate with economic growth and employment, should, under this scenario, prompt the Fed to raise rates.

The current economic context suits the Fed to make such a regime change in its policy. The global economy, not just the U.S economy, must get on the path of investing in industries that increase energy efficiency and use forms of energy other than oil. It is in the interest of American farmers to produce more as the world economy grows to maintain stable food prices as the global demand for food rises.

It is in the interest of all to use more efficient technologies and business processes to minimize resource consumption for minerals so that prices of these commodities do not also rise as fast. The rise in any of these prices can be mitigated by an explicit numerical inflation targeting range that specifies the minimum and maximum inflation, not merely the Fed’s sweet spot which will remain at 1.5 to 2 per cent whatever the upper and lower limits may be, with the realization that 5 per cent is as high as it should ever go for the U.S economy.

All other government policies such as corporate tax rates and trade agreements must ensure these outcomes in support of such a monetary policy by investing both domestically and abroad at the same time, because there are plenty of good reasons why investment is needed around the world.


About Chandrashekar (Chandra) Tamirisa
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