Wednesday, February 27, 2019

Quick note on Interest on reserves and inflation expectations






  1. It strikes me that it was quite reasonable of the Fed to worry that creating hundreds of billions of dollars would lead to inflation. Reasonable. But totally wrong.

    How was the Fed to know? Maybe it should have checked the market signals at the time.

    The Fed's disregarding of market signals is so unfortunate. Hopefully this is improving under Powell. But, it would be so much better to formalize the incorporation of market signals into Fed policy. Like, perhaps with NGDP level targeting.

    The market is going to outperform Fed models every single time. Why not take advantage of it?

    1. Hear! Hear!

      As you know, the irony is that the best way to keep a smaller balance sheet is to raise inflation.

      It's interesting to think of counterfactuals here, isn't it? I mean, imagine if they had not sterilized their emergency loans. If that truly would have been inflationary, then by the time inflation had moved to, say, 4%, the crisis would likely have been averted, because nominal values on all that collapsing collateral would have been stabilized. Exactly where would the equilibrium have kicked in? Would a few billion unsterilized loans in the summer of 2007 have been the end of it?

  2. I understand what Ken Duda is saying, but he is far too kind. The teeth of a recession is not the time to worry about inflation.

    And if a central bank is going to worry about inflation, do what they Reserve Bank of Australia does. Have an inflation band of 2% to 3%.

    Australia has not had a recession in 30 years although it did have a couple minor stretches of 4% inflation.

    Really, is not some moderate inflation an easy price to pay to avoid recession?