Monetary policy: Is there a problem?

Posted: November 13, 2012 in economy
Tags: , ,

THROUGHOUT the recovery, I have used movements in inflation expectations as a gauge for the strength of the economy. I have done so for a few reasons. First, higher inflation is a healthy thing in a recovery like the current one, amid broad deleveraging and when interest rates are stuck near zero. They facilitate adjustment amid nominal rigidities, the most important of which is the inability of the central bank’s policy rate to fall below zero: higher inflation means a more negative, and more stimulative, real interest rate. And second, higher inflation is a reasonable approximation for higher demand. Expectations of rising prices are indicative of expectations for more demand, more spending, and ultimately more production and hiring. Medium-run inflation expectations, as measured by 2-year and 5-year breakeven rates between garden-variety Treasury securities and inflation-protected Treasuries, have been a reliable indicator of the direction of recovery.And so I have become a little worried about America’s economy. Inflation expectations sank in late spring, stabilised and ticked upward over the summer as Europeans acted to prevent a euro-zone meltdown, then rose rapidly in September when the Federal Reserve unveiled a new policy framework which included ongoing asset purchases. I anticipated that this rise would eventually translate into better economic data, and I have …

via Economic Crisis


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