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Strategies & Market Trends : Mish's Global Economic Trend Analysis
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To: mishedlo who wrote (563)2/25/2004 2:36:00 PM
From: CalculatedRisk  Read Replies (2) of 116555
 
A few thoughts on Fed Economist Dr. Orphanides’ recent paper:

Monetary Policy in Deflation: The Liquidity Trap
federalreserve.gov

First, Dr. Orphandides discussion of the Federal Reserve’s thinking during the Depression is illuminating. What stands out is that the Fed was deeply concerned with an asset bubble in 1938, as a repeat of 1929 (clearly no one in the Fed is worried about bubbles these days!)

But more importantly, I believe Orphandides misses the point when he reaches his conclusions. He recommends intervening in longer term instruments to keep inflating the economy: “ … to implement additional monetary expansion by shifting the targeted interest rate to that on successively longer-term instruments, when additional monetary policy easing is warranted at near-zero interest rate.”

I remember once watching as some kids tried to inflate a bicycle inner tube. The tube had a weak spot, and as these kids pumped air into the tube, the weak spot bulged out of the tire, and the tire did not inflate. That is what the Fed is doing now!

Perhaps the Fed has forgotten that the underlying reason for monetary expansion is job growth; GDP growth is secondary. But, instead of jobs, we are getting asset inflation – we have a weak spot in the inner tube! Pump in more money and all we will get is a bigger bubble.

Orphandides disingenuously quotes Keynes, but Keynes would have understood: We need to patch the weak spot first!

This means changes to fiscal and tax policy to ameliorate the undesirable effects of wealth inequality – one of Keynes main arguments - but a subject that is apparently taboo these days.

Best to all!
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