Insanity

BBC News -- Federal Reserve 'close to meeting targets' for US economy:

The Federal Reserve is close to hitting its targets for US employment and 2% inflation, according to the central bank's vice chairman, Stanley Fischer.

In a speech in Colorado, the Fed's number two policymaker was upbeat about the economy's recovery and prospects.

"We are close to our targets," he said on Sunday, adding that jobs growth had been "remarkably resilient".

He did not mention interest rates, but the remarks are likely to fuel debate about when they may rise.

He did not mention interest rates, but I will: They needed interest rates low to get economic growth so they can raise interest rates and undermine the growth. This is their plan for the economy.

We have to stop thinking always in terms of interest rates. We have to find a better way to prevent inflation.

On second thought, no. We don't have to find a better way. We already have a better way to prevent inflation: Paying down debt destroys money. Paying down debt takes money out of circulation. Paying down debt is a way to prevent inflation.

Paying down debt takes money that is in the economy, and takes it out of the economy. It's money that's in the economy that causes prices to go up.

New borrowing is generally for growth: for a new car or a bigger home or for business expansion, stuff that gets counted in GDP. Growth.

But new borrowing also puts money into the economy. And after that first use, the money's in the economy and it circulates. It is "extra" money in the economy. It may be used to purchase more output, or it may be used to bid up prices. The latter is demand-pull inflation.

Most of the "extra" money eventually works its way out of circulation and into savings. Then it has no demand-pull effect. But the debt that was created when the money was created -- the debt remains in the economy. And the cost of servicing it continues to be imposed on the economy; this creates cost-push inflation. Financial cost push.


Anna Schwartz describes demand-pull inflation:

An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits.

Do consumers feel wealthier since the start of quantitative easing? Has our spending been stimulated? Are businesses increasing production? Is the economy "buoyant"?

No.

Is our inflation, what little inflation we have, is it demand-pull inflation?

No.

Does printing money make prices go up, if nobody's spending the money?

No.

If new borrowing leads to a buoyant economy and demand-pull inflation, is raising interest rates an appropriate policy response?

Yes. Perhaps not the best of policy responses, but it does address the problem of new borrowing. But if the economy is not buoyant and inflation is financial cost push, then raising interest rates is bad policy.

Graph #1

Paying down debt is a way to fight inflation.