Search This Blog

Thursday, November 20, 2008

Mainstream economists just don't GET it

Mankiw is finally pointing out that the Fed pumping money into the economy isn't working. Duh. Been there, discussed that.

The sad thing is, he still doesn't get WHY. As is typical of his more classical perspective, he is focusing on inflation expectations being the culprit. It's not the big problem. It is true that with little wiggle room in nominal rates, and with prices falling and expected to fall further, that real rates should rise - which is problematic for the Fed (ie. there is a nominal liquidity trap, which people have been noting for months now will be a problem).

But that's just one small part of the problem. The BIG problem is the overall market uncertainty and consumer confidence drop. Banks, business, people are hoarding their money, reducing credit usage etc and pulling funds from their 401K's and stock market etc. All this means money demand is rocketing up - raising interest rates. And it's not just general market uncertainty, but also INFLATION uncertainty. Yes, deflation is likely in the short-run, but keep in mind that just a few months ago we were all concerned about stagflation. To the extent that is a longer-term concern, inflation uncertainty is higher now. This contributes to hoarding or lack of lending and borrowing --- people are taking a wait-and-see approach.

So, the Fed can announce a price target all they want, but the Fed only has so much control. They can't control inflation uncertainty due to supply-side effects, nor can they control general market uncertainty in times where aggregate demand is free-falling. Further, to the degree that the Fed can't control the money supply in times of crisis (ie. money is endogenous and led by demand for funds), this further limits the Fed's ability to effect the market. I am therefore skeptical that even an announced price target would have much of an effect given the current malaise.

As a matter of fact, Mankiw's very prescription would likely cause inflation uncertainty to skyrocket as X number of people would find the Fed action credible, Y number would not, and Z number would see the current economic crisis making it moot! That could mean an even bigger credit crunch!

Focus needs to be on 2 areas:

1. Quicker use of that $700 billion to buy equity in banks etc to get interbank funds flowing and to try to reduce uncertainty (which is the main culprit).

2. Government spending stimulus of a large-order - a new New Deal.

....Abandon Fed Funds targeting - it's not effective and actually can be doing more harm than good because if interest rates on riskier savings is unaffected by the Fed such that those rates keep rising due to uncertainty, but the Fed keeps trying to push it's interest rate on T-bills down further, all that does is INCREASE demand for hoarding.

I think monetary theory will be completely revamped after this crisis is over with, because I am becoming more and more convinced that the traditional idea that decreasing Fed Funds rate can stimulate the economy is outdated in times like these --- in normal times yes, but not now.


oakleyses said...

polo ralph lauren outlet, michael kors outlet, nike shoes, oakley sunglasses, ray ban sunglasses, michael kors outlet, coach factory outlet, ray ban sunglasses, chanel handbags, jordan shoes, prada outlet, louboutin, burberry outlet, true religion jeans, michael kors outlet, christian louboutin shoes, louis vuitton handbags, tiffany and co, oakley sunglasses, burberry outlet, nike free, louis vuitton, prada handbags, louis vuitton outlet, true religion jeans, gucci outlet, longchamp outlet, louis vuitton outlet, michael kors outlet, coach outlet, longchamp handbags, tiffany and co, michael kors outlet, michael kors outlet, louis vuitton outlet stores, air max, coach purses, tory burch outlet, kate spade handbags, polo ralph lauren outlet, coach outlet store online, louboutin, louboutin outlet, air max, kate spade outlet, longchamp handbags, oakley sunglasses cheap

oakleyses said...

nike roshe run, ray ban pas cher, nike free pas cher, sac louis vuitton, michael kors, sac guess, sac louis vuitton, air max, louis vuitton uk, abercrombie and fitch, oakley pas cher, lululemon, barbour, north face, louboutin, mulberry, polo lacoste, nike air max, vans pas cher, longchamp, vanessa bruno, hollister, hogan outlet, michael kors, air max pas cher, new balance pas cher, ray ban sunglasses, air force, timberland, true religion outlet, true religion outlet, converse pas cher, polo ralph lauren, nike free, north face, sac burberry, hollister, nike tn, nike roshe, sac longchamp, nike trainers, ralph lauren, michael kors pas cher, nike blazer, air max, louis vuitton, air jordan, sac hermes

oakleyses said...

ghd, soccer shoes, canada goose, uggs outlet, canada goose jackets, celine handbags, babyliss pro, birkin bag, reebok outlet, abercrombie and fitch, nike huarache, asics running shoes, longchamp, bottega veneta, lululemon outlet, ugg boots, mcm handbags, hollister, valentino shoes, insanity workout, wedding dresses, rolex watches, ferragamo shoes, jimmy choo outlet, soccer jerseys, ugg pas cher, canada goose, north face outlet, north face jackets, p90x, giuseppe zanotti, chi flat iron, canada goose outlet, canada goose, ugg australia, beats by dre, mont blanc, herve leger, instyler, vans shoes, mac cosmetics, canada goose uk, nfl jerseys, nike roshe run, new balance shoes, ugg, marc jacobs, ugg boots

oakleyses said...

links of london, juicy couture outlet, louis vuitton, moncler, pandora charms, moncler, moncler, vans, pandora jewelry, lancel, louboutin, hollister, karen millen, moncler, air max, iphone 6 cases, parajumpers, ralph lauren, thomas sabo, montre homme, oakley, ugg, rolex watches, toms shoes, baseball bats, ugg, canada goose, coach outlet store online, converse shoes, hollister, canada goose, supra shoes, juicy couture outlet, gucci, moncler, timberland boots, swarovski crystal, converse, pandora charms, moncler outlet, ray ban, wedding dresses, hollister clothing store, swarovski, air max, moncler