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Fed Can Print Money, But It Can't Print Jobs

April 16, 2014 in Economics

By Alan Reynolds


Alan Reynolds

We have all been watching a long mystery with no ending: What the Federal Reserve governors are trying to do, how they intend to do it and why they imagine their efforts will work.

The key questions boil down to two: (1) What target should the Fed aim at, and (2) what policy instruments should it use to hit that target?

The Fed’s only explicit target — an unemployment rate of 6.5% — was shrewdly discarded as “outdated” as that target grew near. Actually, the idea of focusing on unemployment is outdated, since it presumes that high unemployment guarantees low inflation — as though stagflation in 1975 or 1982 could not have happened.

Why not simply target inflation? Ben Bernanke advocated inflation targeting before 2002, when he became Fed chairman. On Nov. 21, 2002, he gave a speech warning that inflation was too low, threatening deflation.

Today, as in 2002 or 1998, many are again warning that inflation is too low — just 1.1% last year when gauged by the deflator for personal-consumption expenditures (PCE), or 1.5% over the past 12 months, according to the March consumer price index.

But the trouble with basing future policy on past inflation news is that inflation is always lower before it moves higher. PCE inflation rates of 0.8% in 1998 and 1.3% in 2002, for example, were followed by 2% inflation in 2003, 2.4% in 2004, and 2.9% in 2005.

In the end, economic growth depends on incentives to expand and improve labor and capital.”

Many other central banks do set inflation targets, but the Fed encourages the popular delusion that central bankers, like central planners, possess the knowledge and skill to boost real economic growth and employment.

Fed officials thus speak of their “dual mandate” to promote growth of the economy and jobs while keeping an eye on inflation.

Prominent economists of all stripes have proposed that the Fed should focus instead on keeping the growth of nominal GDP (NGDP) growing at a steady rate. But growth of NGDP is simply the inflation rate added to the real GDP growth rate. So how does an NGDP target differ from a dual mandate?

The graph above shows that before 2010, the Fed moved the federal funds rate up whenever nominal GDP growth picked up, and also reduced the fed funds rate when it slowed.

The Fed often reacted to NGDP data with a lag — easing …read more

Source: OP-EDS

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