I follow Tim Duy’s Fed Watch, but not carefully. When I say that economics makes my brain hurt, it is this kind of stuff that I’m talking about. I don’t think that most people give much thought to things like “money.” If you do, you will find yourself getting confused and anxious. Money really is just a shared delusion. So when you start talking about money supply and inflation, well, your brain starts boiling and you fear you may explode.
Most people I talk to think inflation works in a simple way. There is a certain amount of cash in the economy. If the government prints more of the money, it will be worth less. This is not how money works at all. But sadly, I cannot tell you how money does work. And sadder still is the fact that no one I’ve ever read has been able to make me understand how money works. It’s like black magic. And the witches and warlocks stirring their cauldron of bubbling brew are the members of the Federal Reserve.
But just because I don’t know what money is, doesn’t mean that I don’t know what those witches and warlocks are doing. But I often wonder what they think they are doing. On 16 December 2015, the Fed raised its target funds rate. But why? We know that raising interest rates will cause the economy to cool down. If inflation is rising, raising interest rates will stop it. This is one thing we know without peering into the bubbling cauldron.
But was there any sign of inflation? No. In fact, inflation has stayed stubbornly below the Fed’s target rate (which is itself far too low) of 2%. But the argument was that inflation could take off. Just yesterday, Heather Long at CNN reported, Has the Federal Reserve Messed Up? But if inflation takes off, the Fed can just raise interest rates — and fast. So what’s the big deal?
On the other of hand, there is the chance that raising interest rates too soon could throw the economy back into recession. And then what would the Fed do? Are there any raven’s feet to drop in the cauldron that would fix the problem? No! The Fed would have no tools whatsoever to fight the recession. We would have to depend upon fiscal policy, which means Congress, which means that nothing would be done.
But Long’s point is that if the Fed can just get interest rates high enough, then they will be able to lower them in case a recession comes along. This is the kind of logic that only idiots in the finance world could think makes sense. It’s like eating poison everyday so you have the option of not eating it when you get sick. But then, as a Rhodes Scholar with a master’s degree from Oxford, I have a feeling that she doesn’t spend much time with people who aren’t in the top 10% of income earners — other than the barista who makes her $5 Salted Caramel Mocha Frappuccino.
So with Heather Long and the rest of the class that never has to worry about losing their jobs talking such nonsense, I was happy to see that Tim Duy was making a more reasonable argument, Yellen Pivots Toward Saving Her Legacy. In particular, he focused on Fed Chair Janet Yellen’s recognition of the extremely asymmetric risks that the economy faces.
It’s really simple. On the one side, you have a small risk of rising inflation that the Fed has more than enough tools to deal with. On the other side, you have what I think is a rather greater risk of recession that the Fed has absolutely no tools to deal with. But I know: Heather Long and the rest of the business “journalists” want to raise rates so the Fed can have tools to deal with a recession. But there is no sense of the risk of gaining those tools. Duy was right when he wrote, “The incoming data suggests that means the economy needs to run hotter for longer if the Fed wants to leave the zero bound behind. Yellen is getting that message.”
So I’m glad that Yellen and (a personal hero) Lael Brainard and others on the Federal Reserve Board are casting their spells for the good of the economy and not the bankers and their mindless “journalist” apologists.