'Another outstanding economist, the late Stanford Professor Ronald McKinnon, analyzed the consequences of policies that are tolerant of inflation and government intervention in credit allocation. For McKinnon when inflation is tolerated, it undermines growth and leads to increased calls for government intervention, thereby pushing countries further in the direction of command-and-control economies. The share of the government sector, with its negative multipliers, increases, while the share of the private sector, with its positive multipliers, declines. This reinforces the upward trend of inflation, perpetuating the cycle.
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..should the Federal Reserve cease in their efforts to calm inflation before it has been fully restrained, bond investors should be wary.''Disaster is a strong but appropriate word that applies perfectly to the state of U.S. monetary policy..
Harm of Favoring Employment Over InflationMost Americans have suffered a substantial fall in their standard of living over the past twelve months. In the latest available twelve-month change, 116.2 million American wage and salary workers suffered a 3.7% decline in their inflation adjusted paychecks, the largest drop since 1980 (Chart 1). This alone more than offsets the gain in income going to the 6.5 million newly employed in latest twelve months. In addition, salary workers suffered a larger loss in standard of living than hourly employees.
Inflationary damage to the 70 million retired Americans cannot be calculated in precise terms, but qualitatively the situation is not good. Those covered by Social Security received a 5.9% cost of living adjustment (COLA), however most private pensioners do not have COLAs. A rough estimate is that approximately 50 million or more retirees’ real income has been seriously eroded by the forty year decade high inflation rate. Summing those whose income trailed price increases (116.2 + 50) yields a figure of approximately 170 million Americans. The sizeable adverse impact of inflation is consistent with a decline in real disposable personal income in 11 of the 13 latest months. Eighty five percent of U.S. households make under $150,000 a year, with many living from paycheck to paycheck or on steady salaries. The imbalance between those who benefitted and those who were harmed from the monetary and fiscal policies pursued over the last two years is abundantly clear. The 8.5% inflation rate has dramatically lowered the standard of living of over 170 million individuals. When this circumstance is compared with the accomplishment of the objective by monetary and fiscal authorities to lower the unemployment rate from a recession high of 14.7% in April of 2020 to 3.6% today, the fallacy of twin mandates is abundantly clear. The lowering of the unemployment rate reflected the creation of 20.4 million new jobs. Is it a fair balance to help 20 million individuals at the expense of permanently harming 180 million?
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Under the Federal Reserve Reform Act of 1977, the Fed expanded its role to “the goals of maximum employment, stable prices, and moderate long-term interest rates.” Ironically, these goals have come to be known as the Fed’s “dual mandate” even though there are three goals. The flawed dual mandate of inflation and unemployment stems from the basic fact that no stable trade-off exists between wage increases and the unemployment rate. To make matters worse, in practice the Fed has allowed the dual mandate to morph into a single mandate centered on the Phillips Curve. The 1977 Act does not spell out the nature of the trade-off between the unemployment rate and the inflation rate nor does it say how the Fed should act if the mandates are at odds in terms of the policy approach (neither does the 1978 Humphrey Hawkins Full Employment Act). Two considerations indicate the influence of the Phillips Curve should have ended long ago: (1) critical theoretical arguments from great monetary theorists, and (2) empirical evidence. (p. 1 & 2)
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In a paper presented at the 2014 Federal Reserve Bank of Chicago conference, Alan Meltzer summarized the root cause of the Fed’s policy errors and long record of failed forecasts as follows: “The Fed’s error was to rely on less reliable models like the Phillips Curve ... that ignore or severely limit the role of money, credit, and relative prices.” By focusing on the Phillips Curve, Meltzer contended that the Fed overemphasizes information in very short monthly and quarterly data periods while giving insufficient information about persistent trends in money and credit, which are the very aggregates that the Fed supplies. In short, by relying on the Phillips Curve, the Fed avoids developing a strategic view of its role and the complex world in which it operates. Volcker explained publicly and to the Fed staff that the Phillips Curve was unreliable and not useful. Alan Greenspan was less outspoken, but he also rejected Phillips Curve forecasts as unreliable. After Greenspan left the Fed, the staff re-established the focus on the Phillips Curve, one of the central dogmas of Keynesian economics.
John Taylor invented a now very famous interest rate forecasting model, which was outlined in his 1993 study, “Discretion versus policy rules in practice.” This model, commonly referred to as the “Taylor rule,” suggests how central banks should change interest rates to account for inflation and other economic conditions.
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Here are Taylor’s prophetic words in the August 12, 2021 issue of Harvard’s Project Syndicate: “Despite a sharp increase in the rate of money growth, the central bank is still engaged in a large-scale asset-purchase program (to the tune of $120 billion per month), and it has kept the federal funds rate in the range of 0.05 to 0.1%. That rate is exceptionally low compared to similar periods in recent history. To understand why it is exceptional, one need look no further than the Fed’s own July 9, 2021, Monetary Policy Report, which includes long-studied policy rules that would prescribe a policy rate higher than the current actual rate. One of these is the “Taylor rule,” which holds that the Fed should set its target federal funds rate according to the gap between actual and targeted inflation.” Later he writes, “If you plug in the current inflation rate over the past four quarters (about 4%), the gap between GDP and its potential for the second quarter (about -2%), a target inflation rate of 2%, and a so-called equilibrium interest rate of 1%, you get a desired federal funds rate of 5%.”
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Another outstanding economist, the late Stanford Professor Ronald McKinnon, analyzed the consequences of policies that are tolerant of inflation and government intervention in credit allocation. For McKinnon when inflation is tolerated, it undermines growth and leads to increased calls for government intervention, thereby pushing countries further in the direction of command-and-control economies. The share of the government sector, with its negative multipliers, increases, while the share of the private sector, with its positive multipliers, declines. This reinforces the upward trend of inflation, perpetuating the cycle.
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Monetary restraint has resulted in recessions in all but 10% of the cases since the Fed’s founding in 1913. Though rare in occurrence, achieving a soft landing or even a mild recession may be a hollow victory. In 1966, the Fed, under Chairman Mechesney Martin caused a credit crunch to try to contain inflation resulting from the Vietnam War. But, under serious pressure from the Johnson administration, the Fed reversed course and avoided a recession in 1967. However, the war inflation surged further out of control. The Martin Fed did induce a recession as a result of a serious credit crunch in 1969. This recession was extremely mild but caused the failure of the largest issuer of commercial paper (Penn Central Railroad) which resulted in a major financial crisis in May 1970. This led the Fed, now under chairman Arthur Burns, to speed up the easing of monetary conditions, including taking the extraordinary step of cutting the margin requirement on stocks. Then, after a severe auto industry strike, GM agreed to a highly inflationary wage settlement with the UAW. In the 1971 recovery, inflation showed little, if any, improvement and the rebound was extremely tepid. Facing a Presidential election in 1972, the Nixon administration simultaneously closed the gold window, engineered a massive devaluation of the dollar and instituted wage and price controls to hold inflation in check while the Burns Fed accelerated money growth at time when money velocity was stable. Growth was fast in 1972 and inflation was contained but, when the wage and price controls were lifted in 1973, inflation surged rapidly, and the Burns Fed was forced to adopt far more restrictive conditions than had been seen in 1966 and 1969. In 1973-75 a very deep recession followed. The Vietnam War/Nixon inflation was not resolved until after three years of severe monetary restraint under the Volcker Fed and deep recessions in the early 1980s. As these historical cases indicate, failure to knock out inflation may achieve better short-run economic performance but a terrible longer-term loss.
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..should the Federal Reserve cease in their efforts to calm inflation before it has been fully restrained, bond investors should be wary.' (p. 4 & 5)
- Dr. Lacy Hunt,
Quarterly Review and Outlook First Quarter 2022, April 20, 2022
Context(Banking Reform - English/Dutch) '..a truly stable financial and monetary system for the twenty-first century..''..the current monetary system, based on credit expansion .. “manic-depressive” behavior..'(Banking Reform) - Issues 2022 - 'Our nation (and the world) was profoundly scarred by the Great Depression experience..'(Banking Reform) - '..the Fed has lost every systematic tether to common sense..' - 'Fed Operations Look More Like a Ponzi Scheme..'(Stagflation)(Real price-inflation at 15%) - '..inflation spiraling completely out of control.'Economists warn of [price] inflation inequality as poor get slammed by rising prices'U.S. inflation is currently 6.8%, the highest rate in the developed world .. Almost universally, rates have been kept lower than the Taylor Rule had suggested..''..a “monstrous” (according to Clemente de Diego) legal institution..'