Wednesday, September 23, 2009

Will the Fed Create a New Bubble?

Steve Pearlstein of the Washington Post puts the question nicely:
For the past two years, the central challenge of U.S. economic policy has been to find a way to stabilize the financial system and the economy without reinflating the bubble or going back to the days of consuming more than we produce. In the end, that may prove harder than it seems.

Exactly.

The difficulty, of course, is politics rather than economics. The Fed unquestionably has the tools to prevent an outburst of inflation, assuming it has the courage to use these tools. But curbing inflation might be hard politicially, since it could require the Fed to raise interest rates when economic recovery is still anemic.

The current situation illustrates why the economy would plausibly be better off without a central bank: beneficial actions today will often soiw the seeds of harmful actions tomorrow.

21 comments:

Ken Wells said...

The appeal of lending to the FDIC has almost nothing to do with the rate of return. We'd rather pay our own way than have the FDIC looking for a "bailout". We don't want the fund or industry appear indebted to the Treasury, and thereby the taxpayer, and thereby the idiots in Congress who will then feel even more emboldened to tell us how to run our businesses, which 98+% of us are running just fine, thank you very much.

Anonymous said...

Under capital reserve regulations banks can only lend so much. So if they lend to the FDIC does this not limit the amount of commercial lending? And does this not in effect allow the FDIC to compete with and partially supersede the Fed's reserve requirements regime? The FDIC ends up looking like a mini-discount window?

Mike said...

http://www.stanford.edu/~johntayl/Debt%20Charts.pdf

http://johnbtaylorsblog.blogspot.com/

Unchartered territory for the U.S..

Mario Rizzo said...

I disagree that the problem is politics rather than economics. (But perhaps the difference in the policy realm is not sharp.) My point is that to the extent the Fed or Treasury stabilizes by attempting to reach the status-quo ante it is reflating the misdirection of resources at the heart of the "bubble." It is only if policy makers can tell the difference between the secondary over-reaction and the necessary movement of resources out of bubble-industries that we can be home-free. Focusing on the price level or aggregate rate oif inflation is not enough. Recall that we had the bubble without "inflation."

Heathcliff said...

I think you meant "sow" instead of "soiw" in the last sentence.

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