Simon and Peter argued in Real Time Economics earlier today that we need some inflation (see the post just before this one) – not only because deflation is bad, but also because it helps protect asset values, including the assets for which the government is now on the hook.
James Hamilton at Econbrowser has a plan for how to create some inflation (he suggests a target of 3%). And if that doesn’t work, he has an even more clever plan.
The Baseline Scenario 
There is no need to create inflation. Someone in other blog post mentioned that it is a theft and I agree.
We need to take much more drastic steps today to restore confidence. Force all major financial institutions to come clean, mark down the asset prices to market, project further losses of 10 to 20% on them due to slowing economy, show their real balance sheet (even if negative) to Govt. I expect their will be around $1 Trillion of further losses. Let govt provide them insurance like it provided to Citi (but there should be upside for govt if asset prices go up). Also, liquidate or merge banks which are in deep red.
Just doing that itself will restore confidence in the markets. Govt may just inject remaining 700B of TARP funds in the banks and encourage them to raise more private capital. I don’t think govt would have to print or add more money.
Ad hoc bailout of individual bank is not going to work. Someone will again start spreading rumors or speculate and drive down stock price of other major bank and we will be running like headless chickens again.
I keep seeing this term over the past few days about the government having to “print more money”. I mean the government doesn’t just “print money”, correct? Isn’t all the funding that the government uses either obtained by tax revenue (which of course is not enough) or the sale of “government debt” in the form of treasury bills, bonds, etc? Are am I way off, the government can simply “print money”?
Thanks
Scott E. Pace MD
Muskogee, OK
Scott, only the Federal Reserve can print money and you are correct that the rest of the government can only pay for things with taxes or debt. However, the government can and is indirectly printing money. Every time the FED has to enter the market to keep the Federal Funds rate at it target it either sells bonds or buys government bonds. If the FED is buying bonds to keep its target low, it is in effect buying government debt with freshly printed cash. This is how irresponsible countries get into trouble. The government spends way more than it can afford and the central bank aides and abets them into hyper-inflation by buying the debt with printed money. In normal times that doesn’t happen here because the FED would (or would be expected to) let rates rise from the irresponsible government spending.
I personally think people don’t realize that there is good inflation and good deflation as well as bad deflation and bad inflation. We don’t want deflation now because it would be the bad kind. Good deflation comes from good productive economics – if the economy is super productive prices can fall while at the same time it pays higher wages and higher profits. Bad deflation is when prices are falling because the economy is so fast into reverse that prices need to decline to sell existing inventory. The problem with bad deflation (and bad inflation) is that normal economic activity grinds to a halt and you end up in a depression (one where you either have tons of worthless cash or one where nobody has anything of value except cash and most of us wont have that either). If you compare Germany of the 1920’s and the US of the 1930’s, you have two equally horrible economies. One imploded from deflation, the other from hyper-inflation.
Right now economists want to create SOME inflation to grease the wheels of the economy and get it growing again. They’re even willing to error on the side of a little too much, because the other option(s) are far worse and far more difficult to deal with once out of control.
Good inflation and bad inflation, agree. But when we have bubbles like current one in asset prices we have to let it deflate. And if we keep on inflating by printing more money, ordinary savers are the people who get ripped off. All others who are culprits in bubbling up prices got away with lot of money.
There should be strict regulations, competent regulators, jail terms and bigger fines. I see no one has been charged with any fraud related activities so far.
Anonymous, I can sympathize with your anger, but this isn’t the time to be looking to fix blame…
…One, because you probably can’t find specific people to blame. When bubbles happen few people complain on the inflating. Even those diligent savers who saw oversized returns weren’t complaining. Right now we need to contain the deflating so that it doesn’t deflate the whole economy (ours and the worlds).
And two, because part of the problem is that there is too much money being unwisely invested in the US. And I mean by countries with huge current account surpluses that refuse to allow their currencies to float against the dollar (mainly China and several oil wealthy nations). While they have their own selfish reasons (which is what drives capitalism, supposedly) the size has grown so large that the distortions on our economy are equally distorted. Bad regulators and bad sub-prime lenders aside, none of it could have happened if there wasn’t so much money flowing back into the US.
We’ve all lived more pampered lives for it, but in a market driven world imbalances are invariably going to correct, it will unfortunately be very painful for all of us. And the number of people complicit in it is far more than any jail can hold. As with raising kids, you have to know which battles to fight, and finding all the evil doers right now is not the right one.
Adam, I agree with you about current mess. But I don’t think current measures taken by govt are working. Right now whatever money these banks are getting from Govt is just going in their hole and not coming to consumers and businesses to prop up economy.
Also, if no one is punished and there is lot of cheap and free money flowing around this will just encourage more reckless behaviors from greedy people and future bubbles. We have to bring confidence back in markets but at the same time make it clear no further reckless behavior will be tolerated. I know this is much difficult to do and achieve than just saying. But some steps need to be taken in this direction as well. To begin with govt should force former executives of bailed out institutions to return their bonuses for past few years.
I totally agree!!! Let’s just hope that’s what happens after January 20th and that we’re all still around by then to see it.
Okay Anonymous, you wrote:
“But I don’t think current measures taken by govt are working. Right now whatever money these banks are getting from Govt is just going in their hole and not coming to consumers and businesses to prop up economy.”
I thought this initial “bailout money” was to be used to acquire bad mortgage loans from the banks at a substantial discount (which the banks couldn’t sell) and for our government to resale them at a later date at a higher basis. Did this not occur?
And Adam and Anonymous, while I agree that those involved have engaged in reckless behavior, was any laws actually broken? Wasn’t this more a result of the Gramm-Leach-Bliley Act (Repeal of Glass-Steagall) in 1999 and in changes in the net capital rule in 2004 (where the U.S. Securities and Exchange Commission agreed unanimously to release the major investment houses from the net capital rule, the requirement that their brokerages hold reserve capital that limited their leverage and risk exposure)?
Scott E. Pace MD
Muskogee, OK 74401
We are seeing Bernanke 2002 in action here. The Federal Reserve is determined to reflate assets to prevent what Adam calls “bad” deflation. The problem is we don’t know what are the true values for these assets. So I demure from calling anything bad or good. Markets will overshoot on either direction and then correct itself. I am fine with dflation as lon as there is no manipulation by a select few are causing that.
The current panics in the financial markets are caused by naked short sellers. Short selling is the ultimate form of leveraging and credit explosion. They complete transactions with no money down. Ban short selling. If you don’t own the asset, you don’t get to sell it. Period. Wake up regulators!
Scot,
I support whatever is being done to get us out of this crisis for mass population. Otherwise many people will be jobless.
“Was any laws broken?”: Probably Not. These people are just too smart. They have lot of money to defend themselves with top lawyers anyway.
But for FUTURE:
Should we keep loopholes open, which allow such kind of reckless behavior? : NO. Tighter regulations and competent regulators are MUST if we want stable growth. Otherwise again we will end up with some bubbled growth which will eventually burst and cause lot of pain.
Some argue, regulations slows down the growth, I agree. But lax regulation could cause complete collapse of global economy like current crisis. This affect poorest people most, some live on daily wages.
Troy,
I agree about short selling. I think at least uptick rule should be back in the game.
Anonymous,
I agree with you, I’m not trying to defend anyone’s behavior. I think when money is involved it seems to deprive individuals of common sense, morality, ethics, etc. whether it’s in high finance, medicine, law or whatever. History has shown time and time again that situations arise when laws and regulations have been watered down that “we” end up in a critical situation.
We cannot leave it up to individuals to do the right thing when money is involved, and regulations must be put in place to protect Main Street from loosing their life savings. I said it before and I’ll say it again, money is the most addictive substance on earth.
Scott E. Pace MD
Initially, I was against creating inflation. But after understanding more about Japanese deflationary spiral in 90s. It looks like may be a right approach to support mass population. But still not sure that it is going to help for long term. What scares me is flow of cheap money from Fed may just create some other bubbles or take us in some other unknown (even worse) territory (one is collapse of dollar).
Along with strict regulations, we should ban all zero percent or very little down loans for anything. Let the buyer put at least 15 to 20% down. Since buyer’s 15-20% will get wiped out first, all buyers will research more before before buying and flippers or speculators will disappear significantly.
“What scares me is flow of cheap money from Fed may just create some other bubbles or take us in some other unknown (even worse) territory (one is collapse of dollar).”
I can’t remember where I read it (maybe even this sight) but…
Ben & Company are doing everything they can to not repeat the mistakes of the 1930’s; but in the end they will only prove to be making different ones. Only time will tell exactly what those new mistakes are. Hindsight is the only thing that’s 20/20.
Dr. Pace is just scratching the surface of what evils are yet to be uncovered. It is disturbing to think that the Fed is actually capable of making an accurate judgement regarding the appropriate value of things by arbitrarily adjusting the value of money.
It is a quintessential disruption in the market that usually leads to catastrophic disaster.
I’m living in Japan now, and have been since 2003. I can tell you that the average person is still not convinced there was ever a recovery. Employment and job growth, even at it’s peak 18 months ago, was low. Furthermore, the gains have been wiped out.
The difference is, there is much less consumer debt here. Much, much less. I bet I can count on one hand the number of Japanese people I know who have a credit card of their own.
The availability of cheap money here goes to the root of justification for bailing out Detroit. The Japanese auto industry has had access to zero percent loans for the better part of the last decade!
The U.S. is repeating the same mistakes that Japan was warned against. #1 NOT writing off bad loans. They hold the property until such a time they can sell it for a “profit” even if it is 10 years. The social system allows the elite special allowances for debt repayment.
#2 You can’t push a rope. Boost demand? Cheap money won’t do it alone, niether will a few public works projects.
The U.S.A has distinct advantages that are not yet being exploited. First, the market is MUCH, MUCH more open than Japan. Therefore we are not forced to buy expensive goods from California, when reasonable goods can be had from Monterrey. Second, MUCH, MUCH higher tolerance for risks, that will hopefully generate innovative solutions to fill the needs of the public, with or without government assistance.
A good clearing out process, would facilitate a better recovery, but that has yet to happen.