Bullard pleads for more money printing

In a recent interview St. Louis Fed president James Bullard gave to the Wall Street Journal's Jon Hilsenrath, he once again reiterated his conversion from someone perceived to be an 'inflation hawk' to someone in favor of more monetary pumping (please note here that since a 'positive rate of inflation' – this is to say, a steady rise in the general price level –  is a declared policy objective of the central bank, there is in reality no such thing as an 'inflation hawk'). It is worth looking at this interview in some detail, as it shows clearly how the monetary bureaucracy drives with its eyes firmly fixed on the rear-view mirror, and bases its policy on an erroneous assumption about the desirability of higher prices.



WSJ: Why the change in policy last week? BULLARD: The outlook was downgraded in the committee statement and I think that just reflected weaker data that had come in. There is no getting around the fact that the outlook is weaker than it had been previously. I would say that the outlook is still positive for the second half of 2010. Most forecasters have positive growth for the third quarter and the fourth quarter and going into 2011. It is a little weaker but I’d still expect that as the most likely outcome. I thought we should be in a position to return to a quantitative easing program if we got further disinflation. Some of the inflation measures are running at 1% or a little below 1%. In particular core CPI is about 0.9% measured from a year ago. That is at the low end of where we might like to be.


OK, but – why? Bullard doesn't say anywhere in the interview why exactly the Fed wants to see a 'core CPI' running above the level it inhabits now. Neither does he tell us what would be bad about a – gasp! – negative core CPI. Contrary to Bullard's hypothesis that rising prices are desirable, we tend to think that most consumers would probably be quite happy to see falling prices. Note here that producers need not suffer either from a fall in prices. What is important for producer profits are relative prices. If their input costs fall to the same extent as their sales prices, they will continue to be profitable.

Bullard's error is the widely held belief that falling prices are synonymous with economic depression. We already mentioned in the past that this view can neither be supported theoretically nor empirically. The fastest period of real economic growth in US history of the past 150 years occurred before the Fed was founded, and coincided with steadily falling prices. Since Bullard does simply not say anywhere why he thinks the price level should always be rising, he seems to assume that this is self-evident.  However, it is not. If falling prices were bad for an industry, the computer industry would not be an engine of economic growth, but would always be in depression. Until Bullard explains how such an 'exception to the rule' can not only exist, but actually thrive, we fail to follow his argument in favor of more inflation.


WSJ: Is the balance sheet now the primary tool for monetary policy? BULLARD: I think it should be and the move to Treasurys is the right one. It is a logical step given the weaker data. I will say also that I don’t think it’s likely that the committee would go with some kind of shock and awe as some of the commentary indicated where you do some big policy move all at once. I wouldn’t advocate that. That is rarely the way the optimal way to run monetary policy. Usually we think of feedback rules that adjust policy instruments a little bit at a time in response to incoming data. If we do return to a quantitative easing program I would advocate a disciplined program which adjusts in response to the outlook and the disinflation risk. You make smaller moves in reaction to data.”


Here Bullard describes the aforementioned 'driving with one's eyes firmly fixed on the rear-view mirror'. The Fed will move 'in reaction to the data', as he puts it. In other words, the Fed is looking at a slice of economic history – which is what the 'data' actually represent, since all they do is to describe the past –  and from that it draws conclusions about what the 'appropriate policy response' should be in the present, in order to affect the future. Bullard also admits that in the end, the Fed's policy is nothing but a series of ad hoc reactions. The planners do not even have a plan. Instead, they will look at what happened over , say the past three months, and based on that will decide whether or not to print more money. This ad hoc policy approach has been  evident since the very beginning of the economic crisis in late 2007 – the Fed has continually reacted in the short term to events, by injecting money into various receptacles (in the beginning the 'special lending facilities' covered an ever expanding circle of recipients). Little thought was given to the long term implications of these actions. Given this approach, we can see how the current 'great experiment' can eventually careen out of control. as there are always leads and lags associated with the Fed's activities.

For instance, the recent bout of economic weakness is  a lagged effect of the slowdown in monetary pumping in late 2009 (as measured by the growth momentum of money AMS and TMS). Given the poor state of the US pool of real funding and the consequent inability of the Fed's pumping to restore boom conditions, it is foreseeable that every slowdown in monetary pumping will have the same effect. This means that the Fed will, according to  Bullard description of the Fed's methodology and goals, constantly find new reasons for ad hoc implementation of new monetary pumping measures. While the inherently deflationary private sector deleveraging process continues, it will therefore build up an ever greater store of 'potential inflationary energy'.

Similar to the post revolution government of France in the late 18th century, it will find that inflationary pushes seemingly 'revive' business activity for a short period, but that as soon as the inflation is slowed down, business activity returns to its previous moribund state. So there  will constantly be incentive to print more and more money. One day the Fed is likely – without even noticing it, due the lag phenomenon – to cross the invisible threshold that lies between the secular deflationary deleveraging trend and a crack-up boom that could destroy the currency altogether. This danger is not appreciated by Bullard and his colleagues, many of whom remain firmly focused on combating the alleged 'threat' of deflation.




James Bullard: in his view, falling prices are the enemy.

(Photo Credit: St. Louis Fed)




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