Posts Tagged 'Martin Feldstein'

Martin Feldstein Just Won’t Stop

Published January 14, 2016 Ben Bernanke , Martin Feldstein , QE 8 Comments
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Martin Feldstein has been warning about the disasters that would befall us thanks to Fed policy for over five years. His November 2, 2010 op-ed piece in the Financial Times (“QE2 is risky and should be limited”) provoked me to write this letter to the editor in response. Feldstein continued assailing QE in 2013 in a May 9 contribution to the Wall Street Journal to which (having become a blogger in 2011) I responded with this post. Stock prices having dropped steeply so far in 2016, Feldstein seems to think now — five years after pronouncing, with the S&P 500 at 1188, stocks overvalued — is a good time for a victory lap.

The sharp fall in share prices last week was a reminder of the vulnerabilities created by years of monetary policy. While chaos in the Chinese stock market may have been the triggering event, it was inevitable that the artificially high prices of U.S. stocks would eventually decline. Even after last week’s market fall, the S&P 500 stock index remains 30% above its historical average. There is no reason to think the correction is finished.

One would like to know by what criterion Feldstein thinks he can discern when stock prices are “artificially high.” Unlike Scott Sumner, I don’t accept the efficient market hypothesis, but I do agree with Scott that it takes a huge dose of chutzpah to claim to know when the entire market is “artificially” high, and an even bigger dose to continue making the claim more or less continuously for over five years even as prices nearly double. And just what does it mean, I wonder, for the S&P 500 index to be 30% above its historical average? Does it mean that PE ratios are 30% above their historical average? Well PE ratios reflect the rates at which expected future profits are discounted. If discount rates are below their historical average, as they surely are, why shouldn’t PE ratios be above their historical average? Well, because Feldstein believes that discount rates are being held down – artificially held down – by Fed policy. That makes high PE ratios are artificially high. Here’s how Feldstein explains it:

The overpriced share values are a direct result of the Federal Reserve’s quantitative easing (QE) policy. Beginning in November 2008 and running through October 2014, the Fed combined massive bond purchases with a commitment to keep short-term interest rates low as a way to hold down long-term interest rates. Chairman Ben Bernanke explained on several occasions that the Fed’s actions were intended to drive up asset prices, thereby increasing household wealth and consumer spending.

The strategy worked well. Share prices jumped 30% in 2013 alone and house prices rose 13% in that year. The resulting rise in wealth increased consumer spending, leading to higher GDP and lower unemployment.

I have to pause here to note that Feldstein is now actually changing his story a bit from the one he used to tell, because in his 2013 Wall Street Journal piece he said this about how well Bernanke’s strategy of holding down interest rates was working.

But despite the Fed’s current purchases of $85 billion a month and an accumulation of more than $2 trillion of long-term assets, the economy is limping along with per capita gross domestic product rising at less than 1% a year. Although it is impossible to know what would happen without the central bank’s asset purchases, the data imply that very little increase in GDP can be attributed to the so-called portfolio-balance effect of the Fed’s actions.

Even if all of the rise in the value of household equities since quantitative easing began could be attributed to the Fed policy, the implied increase in consumer spending would be quite small. According to the Federal Reserve’s Flow of Funds data, the total value of household stocks and mutual funds rose by $3.6 trillion between the end of 2009 and the end of 2012. Since past experience implies that each dollar of increased wealth raises consumer spending by about four cents, the $3.6 trillion rise in the value of equities would raise the level of consumer spending by about $144 billion over three years, equivalent to an annual increase of $48 billion or 0.3% of nominal GDP.

So in 2013, Feldstein dismissed the possibility that the increase in stock prices had had a significant effect on consumer spending. In my 2013 blog post responding to Feldstein, I noted his failure to understand the sophisticated rationale for QE as opposed to the simplistic one that he (and, in fairness, Bernanke himself) attributed to it.

[A]ll that is irrelevant, because the portfolio balance rationale for QE misrepresents the mechanism whereby QE can have any effect. That mechanism is primarily by preventing inflation expectations from dropping. Each one of the QE episodes has been initiated when expectations of inflation were dropping. In each instance, the announcement or even the expectation of QE succeeded in reversing the downward drift of inflation expectations, thereby contributing to expectations of increased profits and cash flows and thus allowing stock prices to recover from their deeply depressed levels after the 2007-09 downturn and panic.

But now Feldstein says that QE really was effective, even though in 2013 he dismissed as inconsequential the mechanism by which QE could have been effective, failing to acknowledge that there was an alternative mechanism by which QE might work. Nevertheless, in today’s op-ed, Feldstein confirms that he still believes that the only way QE can be effective is via the discredited portfolio-balance mechanism.

But excessively low interest rates have caused investors and lenders, in their reach for yield, to accept excessive risks in equities and fixed-income securities, in commercial real estate, and in the overall quality of loans. There is no doubt that many assets are overpriced, and as the Fed normalizes interest rates these prices will fall. It is difficult to know if this will cause widespread financial and economic declines like those seen in 2008. But the persistence of very low interest rates contributes to that systemic risk and to the possibility of economic instability.

Unfortunately, the recently released minutes of December’s Federal Open Market Committee meeting made no mention of financial-industry risks caused by persistent low interest rates for years to come. There was also no suggestion that the Fed might raise interest rates more rapidly to put a damper on the reach for yield that has led to mispriced assets. Instead the FOMC stressed that the federal-funds rate will creep up very slowly and remain below its equilibrium value even after the economy has achieved full employment and the Fed’s target rate of inflation.

Simply asserting that interest rates are “excessively low” is just question begging. What evidence is there that interest rates are excessively low? Interest rates for Treasuries at maturities of two years or more are lower today, after the Fed raised rates in December than they were for much of 2015. Under the Feldstein view of the world, the Fed had been holding down interest rates before December, so why are they lower now than they were before the Fed stopped suppressing them? The answer of course is that the Fed controls only one interest rate in a very narrow sliver of the entire market economy. Interest rates are embedded in a huge, complex and interconnected array of prices for real capital assets, and financial instruments. The structure of all those prices embodies and reflects the entire spectrum of interest rates affecting the economy. It is simply delusional to believe that the Fed can have more than a marginal effect on interest rates, except insofar as it can affect expectations about future prices – about the future value of the dollar. In the absence of evidence that the Fed is affecting inflation expectations, it is a blatant and demonstrable fallacy to maintain that the Fed is forcing interest rates to deviate from equilibrium values that would, but for Fed intervention, otherwise obtain. No doubt, there are indeed many assets that are overpriced, but, for all Professor Feldstein knows, there are just as many that are underpriced.

So Professor Feldstein might really want to take to heart a salutary maxim of Ludwig Wittgenstein: Whereof one cannot speak, thereof one must be silent.

Who Sets the Real Rate of Interest?

Published July 3, 2013 expectations , Federal Reserve , Irving Fisher , Martin Feldstein , Milton Friedman , natural rate of interest , natural rate of unemployment , real interest rates , Uncategorized , Wall Street Journal 49 Comments
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Understanding economics requires, among other things, understanding the distinction between real and nominal variables. Confusion between real and nominal variables is pervasive, constantly presenting barriers to clear thinking, and snares and delusions for the mentally lazy. In this post, I want to talk about the distinction between the real rate of interest and the nominal rate of interest. That distinction has been recognized for at least a couple of centuries, Henry Thornton having mentioned it early in the nineteenth century. But the importance of the distinction wasn’t really fully understood until Irving Fisher made the distinction between the real and nominal rates of interest a key element of his theory of interest and his theory of money, expressing the relationship in algebraic form — what we now call the Fisher equation. Notation varies, but the Fisher equation can be written more or less as follows:

i = r + dP/dt,

where i is the nominal rate, r is the real rate, and dP/dt is the rate of inflation. It is important to bear in mind that the Fisher equation can be understood in two very different ways. It can either represent an ex ante relationship, with dP/dt referring to expected inflation, or it can represent an ex post relationship, with dP/dt referring to actual inflation.

What I want to discuss in this post is the tacit assumption that usually underlies our understanding, and our application, of the ex ante version of the Fisher equation. There are three distinct variables in the Fisher equation: the real and the nominal rates of interest and the rate of inflation. If we think of the Fisher equation as an ex post relationship, it holds identically, because the unobservable ex post real rate is defined as the difference between the nominal rate and the inflation rate. The ex post, or the realized, real rate has no independent existence; it is merely a semantic convention. But if we consider the more interesting interpretation of the Fisher equation as an ex ante relationship, the real interest rate, though still unobservable, is not just a semantic convention. It becomes the theoretically fundamental interest rate of capital theory — the market rate of intertemporal exchange, reflecting, as Fisher masterfully explained in his canonical renderings of the theory of capital and interest, the “fundamental” forces of time preference and the productivity of capital. Because it is determined by economic “fundamentals,” economists of a certain mindset naturally assume that the real interest rate is independent of monetary forces, except insofar as monetary factors are incorporated in inflation expectations. But if money is neutral, at least in the long run, then the real rate has to be independent of monetary factors, at least in the long run. So in most expositions of the Fisher equation, it is tacitly assumed that the real rate can be treated as a parameter determined, outside the model, by the “fundamentals.” With r determined exogenously, fluctuations in i are correlated with, and reflect, changes in expected inflation.

Now there’s an obvious problem with the Fisher equation, which is that in many, if not most, monetary models, going back to Thornton and Wicksell in the nineteenth century, and to Hawtrey and Keynes in the twentieth, and in today’s modern New Keynesian models, it is precisely by way of changes in its lending rate to the banking system that the central bank controls the rate of inflation. And in this framework, the nominal interest rate is negatively correlated with inflation, not positively correlated, as implied by the usual understanding of the Fisher equation. Raising the nominal interest rate reduces inflation, and reducing the nominal interest rate raises inflation. The conventional resolution of this anomaly is that the change in the nominal interest rate is just temporary, so that, after the economy adjusts to the policy of the central bank, the nominal interest rate also adjusts to a level consistent with the exogenous real rate and to the rate of inflation implied by the policy of the central bank. The Fisher equation is thus an equilibrium relationship, while central-bank policy operates by creating a short-term disequilibrium. But the short-term disequilibrium imposed by the central bank cannot be sustained, because the economy inevitably begins an adjustment process that restores the equilibrium real interest rate, a rate determined by fundamental forces that eventually override any nominal interest rate set by the central bank if that rate is inconsistent with the equilibrium real interest rate and the expected rate of inflation.

It was just this analogy between the powerlessness of the central bank to hold the nominal interest rate below the sum of the exogenously determined equilibrium real rate and the expected rate of inflation that led Milton Friedman to the idea of a “natural rate of unemployment” when he argued that monetary policy could not keep the unemployment rate below the “natural rate ground out by the Walrasian system of general equilibrium equations.” Having been used by Wicksell as a synonym for the Fisherian equilibrium real rate, the term “natural rate” was undoubtedly adopted by Friedman, because monetarily induced deviations between the actual rate of unemployment and the natural rate of unemployment set in motion an adjustment process that restores unemployment to its “natural” level, just as any deviation between the nominal interest rate and the sum of the equilibrium real rate and expected inflation triggers an adjustment process that restores equality between the nominal rate and the sum of the equilibrium real rate and expected inflation.

So, if the ability of the central bank to use its power over the nominal rate to control the real rate of interest is as limited as the conventional interpretation of the Fisher equation suggests, here’s my question: When critics of monetary stimulus accuse the Fed of rigging interest rates, using the Fed’s power to keep interest rates “artificially low,” taking bread out of the mouths of widows, orphans and millionaires, what exactly are they talking about? The Fed has no legal power to set interest rates; it can only announce what interest rate it will lend at, and it can buy and sell assets in the market. It has an advantage because it can create the money with which to buy assets. But if you believe that the Fed cannot reduce the rate of unemployment below the “natural rate of unemployment” by printing money, why would you believe that the Fed can reduce the real rate of interest below the “natural rate of interest” by printing money? Martin Feldstein and the Wall Street Journal believe that the Fed is unable to do one, but perfectly able to do the other. Sorry, but I just don’t get it.

Look at the accompanying chart. It tracks the three variables in the Fisher equation (the nominal interest rate, the real interest rate, and expected inflation) from October 1, 2007 to July 2, 2013. To measure the nominal interest rate, I use the yield on 10-year Treasury bonds; to measure the real interest rate, I use the yield on 10-year TIPS; to measure expected inflation, I use the 10-year breakeven TIPS spread. The yield on the 10-year TIPS is an imperfect measure of the real rate, and the 10-year TIPS spread is an imperfect measure of inflation expectations, especially during financial crises, when the rates on TIPS are distorted by illiquidity in the TIPS market. Those aren’t the only problems with identifying the TIPS yield with the real rate and the TIPS spread with inflation expectations, but those variables usually do provide a decent approximation of what is happening to real rates and to inflation expectations over time.

real_and_nominal_interest_rates

Before getting to the main point, I want to make a couple of preliminary observations about the behavior of the real rate over time. First, notice that the real rate declined steadily, with a few small blips, from October 2007 to March 2008, when the Fed was reducing the Fed Funds target rate from 4.75 to 3% as the economy was sliding into a recession that officially began in December 2007. The Fed reduced the Fed Funds target to 2% at the end of April, but real interest rates had already started climbing in early March, so the failure of the FOMC to reduce the Fed Funds target again till October 2008, three weeks after the onset of the financial crisis, clearly meant that there was at least a passive tightening of monetary policy throughout the second and third quarters, helping create the conditions that precipitated the crisis in September. The rapid reduction in the Fed Funds target from 2% in October to 0.25% in December 2008 brought real interest rates down, but, despite the low Fed Funds rate, a lack of liquidity caused a severe tightening of monetary conditions in early 2009, forcing real interest rates to rise sharply until the Fed announced its first QE program in March 2009.

I won’t go into more detail about ups and downs in the real rate since March 2009. Let’s just focus on the overall trend. From that time forward, what we see is a steady decline in real interest rates from over 2% at the start of the initial QE program till real rates bottomed out in early 2012 at just over -1%. So, over a period of three years, there was a steady 3% decline in real interest rates. This was no temporary phenomenon; it was a sustained trend. I have yet to hear anyone explain how the Fed could have single-handedly produced a steady downward trend in real interest rates by way of monetary expansion over a period of three years. To claim that decline in real interest rates was caused by monetary expansion on the part of the Fed flatly contradicts everything that we think we know about the determination of real interest rates. Maybe what we think we know is all wrong. But if it is, people who blame the Fed for a three-year decline in real interest rates that few reputable economists – and certainly no economists that Fed critics pay any attention to — ever thought was achievable by monetary policy ought to provide an explanation for how the Fed suddenly got new and unimagined powers to determine real interest rates. Until they come forward with such an explanation, Fed critics have a major credibility problem.

So please – please — Wall Street Journal editorial page, Martin Feldstein, John Taylor, et al., enlighten us. We’re waiting.

PS Of course, there is a perfectly obvious explanation for the three-year long decline in real interest rates, but not one very attractive to critics of QE. Either the equilibrium real interest rate has been falling since 2009, or the equilibrium real interest rate fell before 2009, but nominal rates adjusted slowly to the reduced real rate. The real interest rate might have adjusted more rapidly to the reduced equilibrium rate, but that would have required expected inflation to have risen. What that means is that sometimes it is the real interest rate, not, as is usually assumed, the nominal rate, that adjusts to the expected rate of inflation. My next post will discuss that alternative understanding of the implicit dynamics of the Fisher equation.

Wherein I Try to Help Robert Waldmann Calm Down

Published May 14, 2013 expectations , inflation , monetary policy , Robert Waldmann 10 Comments
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Brad Delong kindly posted a long extract from my previous post (about Martin Feldstein) on his blog. The post elicited a longish comment from Robert Waldmann who has been annoyed with me for a while, because, well, because he seem to think that I have an unnatural obsession with monetary policy. Now it’s true that I advocate monetary easing, and think monetary policy, properly administered, could help get our economy moving again, but it’s not as if I have said that fiscal policy can’t work or shouldn’t be tried. So I don’t exactly understand why Waldmann keeps insisting that he won’t calm down. Anyway, let’s have a look at Waldmann’s comment.

After making a number of very cogent criticisms of the Feldstein piece that I criticized, Waldman continues:

On the other hand I also disagree with Glasner. This is the usual and I will not calm down.

Well, you maybe you should reconsider.

Then, quoting from my post on Feldstein,

“does he believe the Fed incapable of causing the price level to increase?” Obviously not (it made no sense to type the question) as he fears higher inflation.

That’s true, I started by asking why Feldstein believed a 20% increase in commodity prices was a bubble. I pointed out in my next sentence that if the Fed was causing inflation, then the increase in commodity prices was not a bubble.

I wish for higher inflation, but, unlike Glasner, I don’t hope for it. the Fed has made gigantic efforts to stimulate and inflation is well below the 2% target. What would it take to convince Glasner that the Fed can’t cause higher prices right now ? It seems to me that his faith is completely impervious to data.

OK, fair question. My point is that the Fed is still committed to a 2% inflation target. If the Fed said that it was aiming to increase the price level by 10% within a year and would take whatever steps necessary to raise prices by 10% and failed, that would be a fair test of the theory that the Fed can control the price level. But if the Fed is saying that it’s aiming at a 2% annual increase in the price level, and its undershooting its target, but isn’t even saying that it will do more to increase the rate of inflation, I don’t see that the proposition that the Fed can control the price level has been refuted by the evidence. The gigantic efforts that Waldmann references have all been undertaken in the context of a monetary regime that is committed to not letting the rate of inflation exceed 2%.

Continuing to quote from my post, Waldmann writes:

“Rising asset prices indicate the expectation of QE is inducing investors to shift out of cash into real assets”

Note the clear assumption. QE is the only possible cause of any change in asset prices. Glasner assumes that nothing else changes or that nothing else matters. He basically assumes that there is nothing under the sun but monetary policy.

I think I am being entirely fair to him. I think that, in fact, he assumes not only that monetary policy affects macroeconomic developments but that it is the only thing which affects macroeconomic developments. He has made this very clear when debating me. I think his identifying assumption is indefensible.

Sorry, but where is that clear assumption made? I said that rising asset prices could be attributed to an expectation that QE would increase the rate of inflation. My empirical study showed a strong correlation between inflation expectations and asset values, a correlation not present in the data before 2008. I didn’t say and my empirical study never suggested that asset prices depend on nothing else but inflation expectations, so I am at a loss to understand why Waldmann thinks that that is what I was assuming. What I do say is that monetary policy can affect the price level, not that monetary policy is the only thing that can affect the price level.

Waldmann concludes with a question:

I am curious as to whether there is another possible interpretation of Glasner.

The answer, Professor Waldmann, is yes! Why won’t you take “yes” for an answer? I hope that helps calm you down. It should.

PS I am sorry that I have not responded to comments recently. I have just been too busy. Perhaps over the weekend.

Martin Feldstein Is at It Again

Published May 9, 2013 expectations , inflation , Martin Feldstein , monetary policy 26 Comments
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Martin Feldstein writes in the Wall Street Journal (“The Federal Reserve’s Policy Dead End”)

Quantitative easing . . . is supposed to stimulate the economy by increasing share prices, leading to higher household wealth and therefore to increased consumer spending. Fed Chairman Ben Bernanke has described this as the “portfolio-balance” effect of the Fed’s purchase of long-term government securities instead of the traditional open-market operations that were restricted to buying and selling short-term government obligations.

Here’s how it is supposed to work. When the Fed buys long-term government bonds and mortgage-backed securities, private investors are no longer able to buy those long-term assets. Investors who want long-term securities therefore have to buy equities. That drives up the price of equities, leading to more consumer spending.

What Feldstein fails to ask, much less answer, is why anyone is willing to pay more for the stocks than they are worth (based on expectations of the future net cash flows generated by the underlying assets) just because they have excess cash in their pockets. Feldstein is covertly attributing irrationality to investors, although to be fair, he intimates, and has previously asserted explicitly, that the increase in stock prices since QE started was a bubble. And to be fair one more time, he is accurately characterizing Ben Bernanke’s explanation of how QE is supposed to work.

But despite the Fed’s current purchases of $85 billion a month and an accumulation of more than $2 trillion of long-term assets, the economy is limping along with per capita gross domestic product rising at less than 1% a year. Although it is impossible to know what would happen without the central bank’s asset purchases, the data imply that very little increase in GDP can be attributed to the so-called portfolio-balance effect of the Fed’s actions.

Even if all of the rise in the value of household equities since quantitative easing began could be attributed to the Fed policy, the implied increase in consumer spending would be quite small. According to the Federal Reserve’s Flow of Funds data, the total value of household stocks and mutual funds rose by $3.6 trillion between the end of 2009 and the end of 2012. Since past experience implies that each dollar of increased wealth raises consumer spending by about four cents, the $3.6 trillion rise in the value of equities would raise the level of consumer spending by about $144 billion over three years, equivalent to an annual increase of $48 billion or 0.3% of nominal GDP.

Again, all that is irrelevant, because the portfolio balance rationale for QE misrepresents the mechanism whereby QE can have any effect. That mechanism is primarily by preventing inflation expectations from dropping. Each one of the QE episodes has been initiated when expectations of inflation were dropping. In each instances, the announcement or even the expectation of QE succeeded in reversing the downward drift of inflation expectations, thereby contributing to expectations of increased profits and cash flows and thus allowing stock prices to recover from their deeply depressed levels after the 2007-09 downturn and panic. I explained the underlying theory in my paper “The Fisher Effect under Deflationary Expectations,” which also provided supporting empirical evidence showing of a strong positive correlation since 2008 between inflation expectations as measured by the TIPS spread and stock prices, a correlation not predicted by conventional theory and not observed in the data until 2008.

This 0.3% overstates the potential contribution of quantitative easing to the annual growth of GDP, since some of the increase in the value of household equities resulted from new saving and the resulting portfolio investment rather than from the rise in share prices. More important, the rise in equity prices also reflected a general increase in earnings per share and an increase in investor confidence after 2009 that the economy would not slide back into recession.

Earnings per share of the Standard & Poor’s 500 stocks rose 50% in 2010 and a further 9% in 2011, driving the increase in share prices. The S&P price-earnings ratio actually fell to 17 at the start of 2013 from 21 at the start of 2010, showing the importance of increased earnings rather than an increased demand for equities.

In other words, QE helped to improve earnings, thus validating the expectations that caused the increase in stock prices.

In short, it isn’t at all clear that the Fed’s long-term asset purchases have raised equity values as the portfolio balance theory predicted. Even if it did account for the entire rise in equity values, the increase in household equity wealth would have only a relatively small effect on consumer spending and GDP growth.

Feldstein continues to attack a strawman, albeit one presented to him by Ben Bernanke.

Mr. Bernanke has emphasized that the use of unconventional monetary policy requires a cost-benefit analysis that compares the gains that quantitative easing can achieve with the risks of asset-price bubbles, future inflation, and the other potential effects of a rapidly growing Fed balance sheet. I think the risks are now clear and the benefits are doubtful. The time has come for the Fed to recognize that it cannot stimulate growth and that a stronger recovery must depend on fiscal actions and tax reform by the White House and Congress.

Feldstein’s closing comment reminded me of a piece that he wrote two and a half years ago in the Financial Times entitled “QE2 is risky and should be limited.” Here are the first and last paragraphs of the FT contribution.

The Federal Reserve’s proposed policy of quantitative easing is a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilise the global economy. Although the US economy is weak and the outlook uncertain, QE is not the right remedy.

The truth is there is little more that the Fed can do to raise economic activity. What is required is action by the president and Congress: to help homeowners with negative equity and businesses that cannot get credit, to remove the threat of higher tax rates, and reduce the out-year fiscal deficits. Any QE should be limited and temporary.

I was not yet blogging in 2010, but I was annoyed enough by Feldstein to write this letter to the editor.

Sir, Arguing against quantitative easing, Martin Feldstein (“QE2 is risky and should be limited“, Comment, November 3) asserts that Federal Reserve signals that it would engage in QE, having depressed long-term interest rates, are fuelling asset and commodities bubbles that will burst once interest rates return to normal levels.

In fact, since Ben Bernanke made known his intent to ease monetary policy on August 29, longer-term rates have edged up. So rising asset and commodities prices are due not to falling long-term rates, but to expectations of rising future revenue streams. Investors, evidently, anticipate either rising output, rising prices or, most likely, some of both.

Why Mr Feldstein considers the recent modest rise in commodities and asset prices (the S&P is still more than 20 per cent below its 2007 all-time high) to be a bubble is not clear. Does he believe that with 15m US workers unemployed, expectations of increased output are irrational? Or does he believe the Fed incapable of causing the price level to increase? It would be odd if it were the latter, because Mr Feldstein goes on to insist that QE is dangerous because it may cause an “unwanted rise in inflation”?

Perhaps Mr Feldstein thinks that expectations of rising prices and rising output are inconsistent with expectations that interest rates will not rise sharply in the future, so that asset prices must take a hit when interest rates finally do rise. But he acknowledges that expectations of future inflation may allow real rates to fall into negative territory to reflect the current dismal economic climate. Since August 29, rates on inflation-adjusted Tips bonds have fallen below zero. Rising asset prices indicate the expectation of QE is inducing investors to shift out of cash into real assets, presaging increased real investment and a pick-up in recovery.

Why then is inflation “unwanted”? Mr Feldstein maintains that it would jeopardise the credibility of the Fed’s long-term inflation strategy. But it is not clear why Fed credibility would be jeopardised more by a temporary increase, than by a temporary decrease, in inflation, or, indeed, why credibility would be jeopardised at all by a short-term increase in inflation to compensate for a prior short-term decrease? The inflexible conception of inflation targeting espoused by Mr Feldstein, painfully articulated in Federal Open Market Committee minutes, led the Fed into a disastrous tightening of monetary policy between March and October 2008, while the US economy was falling into a deepening recession because of a misplaced concern that rising oil and food prices would cause inflation expectations to run out of control.

Two years later, Mr Feldstein, having learnt nothing and forgotten nothing, is urging the Fed to persist in its earlier mistake because of a neurotic concern that inflation expectations may soar amid massive unemployment and idle resources.

Well, that’s my story and I’m sticking to it.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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