Dissecting The Problem (Down To The Bone)

Tim Duy’s Fed Watch let’s it fly in this post about the hurdles facing the economy courtesy of a central bank that tolerates passive tightening. In summary, Duy asserts: “Don’t Let Monetary Policy Off The Hook.” He charges that Fed Chairman Bernanke, via testimony earlier this week, is engaged in “a clear effort to shift the focus away from monetary policy onto the fiscal side of the equation,” a strategy that Duy argues is seriously flawed.

Duy cuts to the chase, arguing that “the Federal Reserve needs to take responsibility for ending the liquidity trap.” But the “stumbling block to real change” is a fear of inflation–a fear that “prevents the Federal Reserve from making an unconditional commitment” to end the liquidity trap. At this point, Duy let’s loose:

It is virtually impossible to imagine reestablishing the pre-recession nominal GDP trend, and entirely impossible to regain the pre-recession price trend, without accepting a temporary acceleration of inflation along the way.

More succinctly, we will not lift the economy off the zero-bound without accepting higher than 2% inflation. Since the Federal Reserve has made it clear they will not accept inflation greater than 2%, the economy will not clear the zero-bound. And if the economy does not clear the zero-bound, we will be faced with perpetual and unavoidable deficit spending.

Deficit spending is not accommodated by the Federal Reserve via low interest rates; it is made necessary because the Federal Reserve sees no urgency ending the lower bound challenge. Which means it is ridiculous to believe that the Fed can dump off this problem on fiscal policymakers. How can the state of monetary policy have deteriorated so much that now even Bernanke claims “regulation” is holding back the economy? Yet here we are.

And here is where we’ll probably stay unless Bernanke wakes up one morning and decides that it’s time for a different agenda. It is time (in fact the hour is late), but it’s up to central bankers to act. They seem to be acting at bit more these days at the Bank of England, which “announced its biggest stimulus since the depths of the recession, citing ‘vulnerabilities’ related to the euro-area turmoil.”
Meantime, all is quiet at 20th and Constitution Avenue. Zzzz….