Consumer inflation rose at 1.1% last month, with even the dreaded core inflation posting higher than expected increases. I'd say it was clear before, but if it wasn't then, it sure is now: the attempt to ride out the oil and monetary shocks with monetary stimulus is not a good idea.
As inflation hawks go, I'm not particularly hawkish. I think moderate inflation is good, since it relieves the stickiness of nominal wages and helps the economy adjust to mild shocks. But the current inflationary cycle is moving past "moderate" into "dangerous" at a rapid clip. When the central banker tries too hard to balance unemployment and inflation, the result is creeping inflation that eventually has to be shut down painfully--just ask Paul Volcker.
The Federal Reserve has spent 25 years winning back the inflation fighting credibility that it lost during the 1960s and 1970s. Inflation has been fought so successfully that inflationary expectations are no longer even a glimmer in peoples' financial calculations. But a few more months of this, and that will start to change. The Federal Reserve will have to clamp down, hard, to prevent high inflationary expectations from being written into contracts and labor agreements. Better a moderate recession now than a really severe one when the Fed has to wring the inflation out of the economy.
Worse yet, the Fed's credibility will be much harder to rebuild the second time around. Once is an aberration; twice is a pattern. It's time to bite the bullet and raise rates.
Where were you six months ago? Also, we'll have to see if the oil declines of yesterday and today hold. That will skew things. Then again, "B-52" Ben has little(if any) credibility left. He was reminded of that fact yesterday during his Senate testimony.
Now I know that it is worthless to argue alternate history, but what if the Fed had fought inflation during the 70s? What evidence is there that such monetary policies would have resulted in a recession rather than a depression? If I recall correctly, Volker's recession of the 80s didn't end until oil prices had finally come down to the pre embargo levels of the early 70s. In one sense it looks like we inflated our way out of a depression.
You're on a tear for calling on someone to tear down something lately. Maybe it's time to tear that paradigm a new one...
Now if only my family and I could find a way to pay for just the "core" items. Everytime I hear this term, I get crazy.
Lots of economists, Tom Sargent and John Taylor in particular, have been warning for some time that recent experience with persistently low inflation may be weakening the anti-inflation consensus and may get us back to the bad old days.
For instance, Sargent writes in 'Evolving Post-World War II U.S. Inflation
Dynamics' (2001) that
"Recently, John Taylor (1998) has warned about recidivism on the natural rate hypothesis. Taylor notes that inflation is lower and more stable in the current monetary regime, and he points out that as such data accumulate, erroneous econometric tests of long-run neutrality may again begin to suggest the existence of a [long-run] trade-off [between inflation and output]. To the extent that the tests undermine confidence in the natural rate hypothesis, they could also undermine support for a low inflation policy. In this section, we offer quantitative evidence to back up Taylor’s warning."
http://homepages.nyu.edu/~ts43/RESEARCH/l12.pdf
Welcome to the 1970s! Megan is of course correct, this needs to be nipped in the bud before things get out of hand. We'll see if Bernanke has the courage to do it though.
I guess if inflation gets a little out of control it would make my student loans less painful.
KevDog, every time I hear the argument implied in your comment, I get crazy.
The point of inflation numbers is not to measure any one family's monthly budget, but to measure the general price level. The price of one or two things (even things the people really, really like or need) is not the same as the price of *everything*.
It's best not to try to apply "common sense" definitions to technical terms in complex fields. Instead of making other look foolish, it tends to boomerang onto you.
[Posted with my real name, because I don't believe Ms. McArdle *has* brownshirts!]
I have a secure job with a salary and pension tied to CPI. I have a big new mortgage. INFLATE BEN BABY! INFLATE!
Ok, maybe it's not the best idea to formulate monetary policy just to please me (though it is quite appealling), but isn't it kind of insane to go all gung ho inflation fighter right after sending out all those stimulus checks?
"Consumer inflation rose 1.1% last month"
I can't believe you wrote that. Just yesterday I was noting how long it had been since I had seen anyone in the media make the mistake of confusing an increase in prices with an increase in inflation. I never expected you of all people to make it.
You meant "Consumer prices rose 1.1% last month", which, as it happens, for this month does indicate an increase in the inflation rate, as last month consumer prices presumably rose less than 1.1%.
"It's best not to try to apply "common sense" definitions to technical terms in complex fields. Instead of making other look foolish, it tends to boomerang onto you."
Why not just come out and call me foolish then? Besides making a massive assumption about my level of understanding, maybe you could ask me what I meant.
This "core" number is mentioned in every piece of reporting about inflation, month after month, as if it had some actual relevance. Personally, I look at it as a fudge factor to make economists calculations easier. It's like an engineering problem: "If we just ignore friction and the force of gravity, look how much easier the math is!"
I understand the point of the number, and am actually capable of doing the math, thank you very much. But that doesn't mean the number is worth anything. Just because it can be calculated doesn't mean it should be.
DevDog writes on core inflation: "I understand the point of the number...but that doesn't mean the number is worth anything."
What in your view is the point of the number?
What in your view is the point of the core inflation number?
1) Current Core inflation is a better of future headline inflation than current headline inflation. Core inflation helps one forecast future inflation. Core inflation at 5% per year along with headline inflation of 5% historically pretty much predicts 5% headline inflation next year, while Core inflation at 0% with headline inflation at 5% predicts headline inflation much less than 5% next years.
So if you care about future inflation and not just past inflation you should care about core inflation.
2) Core inflation is about gradual changes in sticky prices, while non-core inflation is about pretty high frequency changes in flexible prices. To the extent that there are welfare effects from monetary policy in the models most central banks use today, these welfare effects stem from the behavior of these sticky prices (which may do things that are not optimal for welfare since they only adjust gradually to changes in economic circumstances), not from the behavior of flexible prices (which pretty much do the welfare maximizing thing given resources and preferences). If there is less oil around real oil prices go up: there is little the central bank can do about that. And raising interest rates to lower sticky prices (and sticky wages) to push down nominal oil prices isn't the right way to go. Hence the attention to core inflation by central banks who care about welfare.
There is a lot more arcane theory behind this point, but I won't go there.
Megan writes, "Better a moderate recession now than a really severe one when the Fed has to wring the inflation out of the economy."
How (and I'm not being snarky here) does Helicopter Ben ensure that tightening here results in only a "moderate recession?" If we're already in a recession, then tightening might cause a very serious economic slowdown. The Fed's current operating assumption is that the slowing economy will moderate demand, thus bringing inflation lower. As of the last couple (oil down over $11/gal) of days, it looks like it may be starting to work.
stefan:
The problem is that the government likely fudges numbers. The other problem is that core inflation means shit to the average consumer who sees food and fuel prices steadily rising(especially when wages are declining).
1) "The problem is that the government likely fudges numbers."
Core inflation isn't more fudged now relative to headline inflation than in the past. Why do you think that fudging explains why Core inflation has stayed low while headline inflation has gone up?
2) "The other problem is that core inflation means shit to the average consumer who sees food and fuel prices steadily rising(especially when wages are declining)."
As I explained above, current Core inflation is a much better predictor of future headline inflation that current headline inflation. To the extent that the average consumer worries about the erosion of their real income in the future, the average consumer should care about Core inflation.
gab:
You take two days as a trend? We had the same thing happen a few weeks ago, only to see oil go higher again. Do you trust Bernanke? Didn't he say a year ago that the housing crisis was contained? I wonder how he thinks that egg tastes now.
I could not agree with Megan's argument more strongly. The Fed is foolish to attempt to 'grow' our way out of this recession in the near term. Unemployment, at 5.5%, is below the post-war average. It should not even be on the Fed's radar screen right now given the magnitude of the other pressures tearing through the economy.
In fact, what goes underreported is that the rapid rate cuts from 5.25% to 2% over the past 9 months are one of the largest drivers of oil exploding from $80 to $140 per barrel during the same timeframe. Keeping rates low to encourage growth will further structurally weaken the dollar. Tack on the deficit pressures that a GSE bailout will bring, and you can easily envision another 15% decline in the dollar over the next 12 mos.
The sad reality, however, is that when faced with a massive debt overhang, governments have to either cut spending, raise taxes, or inflate their way out of debt. Most governments since the advent of the nation state have chosen the latter. America is no exception.
I think it was 2 days ago that the 30 year bond price dropped 1 12/32. Of course the number keeps its own counsel as to the reasons: the government needing to back the FMs, inflationary expectation? How does that do for you in terms of raising rates?
As I explained above, current Core inflation is a much better predictor of future headline inflation that current headline inflation. To the extent that the average consumer worries about the erosion of their real income in the future, the average consumer should care about Core inflation.
Core excludes the basic necessities people buy on a regular basis. People buy groceries and gas to fill up their car every week. They don't buy a house or pickup every week so your argument makes no sense. Also, if you think the government doesn't underestimate inflation, I suggest you read Calculated Risk or The Big Picture. They can explain it better than I can. It's their job to know about stuff like that.
The yield curve is a straight friggin' line after about 6m. So, it looks like the bond market isn't expecting Bernanke to go Voelker at the moment. I sure hope Bernanke is ready to surprise and pounce.
"Core excludes the basic necessities people buy on a regular basis. People buy groceries and gas to fill up their car every week. They don't buy a house or pickup every week so your argument makes no sense."
Core inflation this year is a better predictor of grocery and gas inflation next year than grocery and gas inflation this year is. So if you care about grocery and gas inflation next year you should look to Core inflation this year. What part of that makes no sense to you?
"Also, if you think the government doesn't underestimate inflation, I suggest you read Calculated Risk or The Big Picture. They can explain it better than I can. It's their job to know about stuff like that."
What I'm claiming is that any underestimate of inflation is stable over recent years and doesn't account for the contained level of Core inflation this year compared to the level of Core inflation in the recent past. If you have a link to CR or BP that suggests otherwise please let me know. That would be big and interesting news.
I saw
http://www.econbrowser.com/archives/2008/07/the_governments.html
on this topic. I don't see any changes in CPI bias in recent years.
Noooooooooo! I just took out law school loans!
I wrote that "What I'm claiming is that any underestimate of inflation is stable over recent years and doesn't account for the contained level of Core inflation this year compared to the level of Core inflation in the recent past. If you have a link to CR or BP that suggests otherwise please let me know. That would be big and interesting news."
This neglects the time series properties of the owner equivalent rent series in the CPI, which is in the Core CPI and which does have some interesting properties related to the way utilities (i.e. energy prices) price move. Am I missing anything outside of that?
You know, wasn't it Friedman who predicted the collapse of the Phillips curve?
I heard in the other thread that any of Friedman's work could get overturned by revolutionary ideas at any moment. Hey maybe we'll find out that we can balance on a Phillips Curve forever. It's the Next Big Thing.
"The Fed's current operating assumption is that the slowing economy will moderate demand, thus bringing inflation lower. As of the last couple (oil down over $11/gal) of days, it looks like it may be starting to work. "
Does that really work, since commodities are priced globally? I guess a global slowdown would do the trick, though not pretty for anyone.
Does two days a trend make? Sometimes. But let's discuss other (better) inflation indicators. Gold is below the peaks of March, as is silver. As is copper (aka "the commodity with a PhD in economics.) Most grains as well. The dollar is above the lows of March. So there is evidence that mkt based inflation measures indicate that inflation is not increasing.
And my original question still holds - if we are in a recession already, how do we prevent a tightening move from pushing us into a very serious economic slowdown?
Ha. I said raise the rates about three years ago. Of course, I'm no expert and based my simplistic opinion on nothing more than a feeling that interest rates were too low and problems would arise therefrom.
Was I talking too soon? Perhaps. Do I really know why exactly I thought rates were too low and money supply increases were rapid? Nope. But I guess my hunch was right.
Personally, I think the paradigm of employment and inflation that the Fed tries to balance is misguided.
Also, is the heavy deficit spending that precedes these run-away inflation periods a coincidence or part of a larger truth that the Fed doesn't take seriously? Not sure.
The rents for a big chunk of our energy budget went up. Rents are always "uneconomic" in that they distort risk/reward/effort calculations by economic actors.
The parasitic action of rents can weaken the system so much that a recession sets in. Rule #1 for a successful parasite is don't kill the host. Feedback for a weaken economy and adjustment to new price levels will lower consumption, decreasing rents.
The easy way out is to trade cheaper and cheaper dollars for the oil.
Both are happening and the Fed can't do much about it except make the adjustments even more painful like the Fed and government did in the Great Depression.
The REAL solution is in large part drilling although I'm not nearly as sanguine about the results as many rightwingers. We'll also have to get cranking on coal-to-liquids and oil shale. The Warmist agenda is an attempt to block those new substitutes for petroleum.
You people are seriously deluded.
You think the economy is in the tank now ... just wait until the Federal Reserve starts raising interest rates, Jimmy Carter style, to prevent inflation.
I have news for you folks ... in 1970 40% of mortgages were not priced based on the current interest rate.
Today, we have something called a variable rate mortgage. That means that if the Fed starts raising interest rates ... the price of my HOUSE goes up. My monthly mortgage payment is set by the Fed.
If the Fed raises interest rates above 2%, I, and millions of others, will simply stop paying for our homes and turn them over to the banks. We will have no choice. We cannot pay 6%, 7%, 8%, 9% 10% interest on our monthly mortgages just because the Fed wants to fight the rising price of a carton of eggs.
When we stop paying our mortgages, this will destroy the value of YOUR home, as the foreclosures FLOOD your neighborhood, destroying the value of your primary inflation-fighting asset.
If the Fed has any sense, it will stop acting like it's 1970 ... because in 1970, there was no such thing as a variable rate mortgage.
While in the short term the price of oil is not a good predictor of inflation, in the long term it has been nearly perfect. We experience inflation until the value of oil returns to the historical average. If that happens now, we're screwed. Maybe it won't happen. Our wealth is less dependant on oil than it used to be.
If the Fed raises interest rates above 2%, I, and millions of others, will simply stop paying for our homes and turn them over to the banks....When we stop paying our mortgages, this will destroy the value of YOUR home, as the foreclosures FLOOD your neighborhood, destroying the value of your primary inflation-fighting asset.
Serves us right for trying to bring you people into the landowning class. I said it was a bad idea, letting you lot out of the tenements, but did anyone listen? Nooooooo....
When we stop paying our mortgages, this will destroy the value of YOUR home, as the foreclosures FLOOD your neighborhood, destroying the value of your primary inflation-fighting asset.
Are you kidding? I'll buy up an entire cul-de-sac at fire-sale prices, tear town the houses, and have myself a multi-acre back yard. Bring it on. (It helps that I'm renting).
Please take a moment and shed a tear for those in Zimbabwe where the official inflation numbers are reported at 2.2 MILLION percent.
http://www.cbc.ca/world/story/2008/07/16/zimbabwe.html?ref=rss
What I can't figure out is how they can print money fast enough to keep up.
The floggings (recession) will continue until morale (inflation expectations) improve.
A prediction:
1. Housing, having peaked, will get moved back into the CPI. This will provide add'l elbow room for the govt to understate subsequent inflation by balancing it out.
2. 7% annual inflation (understated, per pt 1 above, so it doesn't even look so bad) cuts your real debts in half in about 10 years.
3. All debts are eventually repaid; if not by the borrower, then by the lender. The borrowers have more votes and would never forgive any govt in power if they, the borrowers, lost their homes.
4. Also, new home buyers still want in. Young people still want a home. So do immigrants.
5. Put it all together, and the path of least resistance for the Fed is to understate inflation, but let it cut the real cost of a house in half in ten years, all w/out giving the borrowers enough incentive (ie, a huge nominal housing price drop) for a mass default.
6. Full bonus for cynical pols: govt bond debt also gets cut in half, freeing up the funds so that they can bribe the voters with that much more of the voters' own money. Foreign bond holders will not like it, but they don't vote, and better still can be assuaged anyway on a case by case basis, giving the US govt serious diplomatic leverage for years to come.
7. Still think the govt doesn't actually want more inflation? I don't.
ratewatcher,
Point of clatrification:
you say:
"raising interest rates, Jimmy Carter style, to prevent inflation."
The rates were seriously raised during Reagan's first term by VOLCKER.
Carter had nothing to do with it and neither did Reagan for that matter.
Fed Policy is important...no doubt...probably more influential over real life, in real time and in our daily life than nearly anything any President does. But to bring presidents into the discussion is totally off base.
Volcker did what he had to do and I don't blame him. But president gets credit for it....or blame...unless you want to split hairs and get into what caused the Fed back in the 60s and 70s to follow policies that caused stagflation. And even there, Carter is a minor character.
CORRECTION:
the president gets NO credit...or blame....
In Check: That was actually in the news recenty, they linked to it from Marginal Revolution. Basically, some German company (probably state-owned) prints the money, but they eventually joined the embargo. Zimbabwe paid for the currency with money seized from travelers at the border, according to one of the posters.
I have to admit that is kind of funny how that works out: "Hey, print up a trillion units of our country's currency and send it over. Payment? Uh ... you can keep 1/5. And like, don't print anymore, k?"
Foreign bond holders will not like it, but they don't vote, and better still can be assuaged anyway on a case by case basis, giving the US govt serious diplomatic leverage for years to come.
Oh but they do vote, with their wallets. They can send the dollar plunging. I think what makes your scenario very unlikely is the unsustainability $12/gallon gasoline. Americans will start rioting in the streets if their commutes get much more expensive. Politicians can deal with fairly largish numbers of people losing their homes (after all, these are mostly skewed toward downmarket Americans, and it's not like the bulk of them will actually end up homeless in any event), but the economy (and most importantly the politicians) really can't, I reckon, withstand much more weak dollar-induced energy inflation. Also, the nation's most activist voters are also those most likely to really suffer pain from inflation. Something's gotta give. I think we'll see rate hikes sooner rather than later.
KevDog, why don't you complain that OBP doesn't include sacrifice bunts? I mean, in the real world, the player was up at bat, and the player got an out, and that was a real out that counted just the same as any other outs in the game, so why exclude it from the stat? That just makes the stat have nothing to do with reality.
John V,
Jimmy Carter was the President of the United States from 1977 until he was unceremoniously booted from office by the Iranian people, who made him a laughingstock.
When he took office, rates for home loans were 8.84%, according to the Federal Reserve. When he left office in 1981, interest rates for home loans were the highest ever in history:
1977, 8.84
1978, 9.63
1979, 11.19
1980, 13.77
1981, 16.63
http://www.federalreserve.gov/releases/H15/data/Annual/H15_MORTG_NA.txt
I reiterate my point: Nobody is going to pay 16% interest on a variable home mortgage for a house they purchased 2 years ago when interest rates were 5%.
Instead, we're going to do what the law allows us to do, which is to forfeit the home to the bank. This isn't immoral ... it's BUSINESS.
The bank is going to DUMP the house on YOUR market. This will destroy YOUR home value (which I will not care about, since the FED will have already destroyed the value of my home.)
So, you guys rooting for the Federal Reserve to "reign in core inflation" had better understand that even though YOU don't have a variable rate mortgage, I do.
And what screws me over screws you over.
It's not the 1970s. The Fed's POWER to raise interest rates to reign in inflation simply no longer exists because the Fed allows variable rate mortgages to exist. It could, by stroke of PEN, tomorrow, convert all ARMs to today's fixed rate, and end the financial crisis.
But, sadly, stupid people are in charge.
ratewatcher: The Fed is stupid for not retroactively voiding contracts?
****
I don't care if home prices collapse. I rent. Oh, but the demand contracts? No, labor gets cheaper and inflation gets reigned in.
Let's bring back the days of nominal interest rates exceeding inflation.
Nah, I'm feeling greedy today: Let's bring back the days of after-tax real treasury yields being postive. YEAH!
What is needed is leadership out of Washington. Some with simple common sense.
http://pacificgatepost.blogspot.com/2008/07/where-is-economic-leadership.html
"Consumer inflation rose 1.1% last month"
Good catch Scott. That's pretty embarrassing language from someone who studied economics.
As for inflation, I don't even know what it is. It seems to consensus definition is a rise in the CPI. Although there is certainly a correlation, is seems silly to trust a government number. On the other hand, the entire economy is a proverbial house of cards that works on psychology as much as anything else, so numbers matter. The CPI should give the powers that be some sense of what the polis is feeling and I have no insight into whether it does so or not. I suspect that the PTB certainly try to make it so. In my layman's view, over time, a measurement of inflation should add up to the debasement of the currency minus improvements in productivity--but I admit to knowing nothing of economics.
Weighing in as usual to remind everyone of the early 20th-century corruption of the word "inflation" that has forever blinded us to certain economic truths.
Inflation is an increase in the money supply. It is NOT an increase in the price level, as the term was redefined.
In this light, Milton Friedman's famous declaration that inflation is "everywhere and always a monetary phenomenon" is easy to understand. Of COURSE it's caused by money, it is ENTIRELY ABOUT money. Rising prices due to oil is not inflation, it is a supply shock. Same story when wages rise due to productivity or legislation. Only an increase in the money supply creates inflation.
Realizing this also reveals the idea of the Fed "controlling" inflation as comical. The Fed is the primary cause of inflation in America. The value of a dollar was relatively steady from its inception to the founding of the Fed, at which point inflation took off like a rocket and has never returned to pre-central banking levels, leaving the value of a dollar at a miniscule fraction of what it once was. The Fed does not have any inflation-fighting credibility to lose, because the Fed EXISTS to inflate. That is its purpose.
ratewatcher,
keep a few things in mind:
I seek to defend neither Carter or Reagan, because, politics aside, neither was responsible for the rate hikes, the Fed was and the Fed still is.
Carter and Reagan are footnotes throughout that ordeal. Again, it's not their doing.
Volker did what he did to stop stagflation. I don't blame him. He didn't set up the conditions that needed the action he took. Over and above that, again, it was the Fed's fault that we got in that position in the first place. The Fed's mandate is flawed and I do not support what it does. And it bothers me to see smart people pretend that the Fed's mandate is not flawed and that they couldn't see this coming. They know too much for their own good....Bernanke included.
But again, the bottom line:
The Presidents were as much to blame for the rate as JR Ewing from Dallas.
The Presidents were as much to blame for the rate as JR Ewing from Dallas.
That bastard! I'm glad he got shot.
To Person,
What's wrong with retroactively voiding contracts that, in hindsight, have eliminated the Fed's ability to fight inflation? My contract is between me, and the Fed, through the bank it regulates and empowers to make the very loan they made to me.
The Fed makes the banking rules ... it can (and does) change the rules all the time, proactively, and retroactively. There's nothing new here. It can void the contract it created as long as I agree and I will agree if it's in my interest to do so.
It is the adjustable rate mortgage that prevents the Federal Reserve from being able to raise interest rates to control inflation - and that's the only weapon the Fed had.
Raising interest rates to flight inflation, while it worked in the 1970s, would be DISASTROUS today. Housing is the highest priced thing that people pay for in today's economy, and the Fed controls the price now (since it sets the variable interest rate.)
This was mostly not true in the 1970s.
Raising interest rates on the 35-40% of people who now own adjustable rate mortgages would ACCELERATE inflation massively (assuming it does not lead to a depression worse than what occurred in the 1930s.) Millions of people would become homeless. Right now, the housing crisis is only being caused by mere hundreds of thousands of mostly poor people ... but if the Fed raises interest rates, ALL PEOPLE will be affected.
Think about what those people are going to do as the Fed raises rates. They're going to do one of two things: stop paying for the homes they can no longer afford, or demand pay increases to pay for them.
Either way, YOU lose.
If millions are forced to give their homes back to the very Fed that insists on charging them usurious interest, then YOU sir are going to be screwed just as royally as me, even if you were "smart enough" not to purchase an ARM.
That's because the Fed, through its member bank, is going to DUMP that house on your market for pennies on its dollar, lowering the value of all property that surrounds it. Your property.
Your house is your largest hedge against inflation - unless the Fed destroys its value by forcing millions of people out of their homes by charging obscene interest rates on adjustable rate mortgages.
So, if you're smart, you're on the phone with your lawmaker urging them to urge the Fed to keep a lid on interest rates.
If the Fed raises rates, get ready for ARMegeddon.
Ratewatcher, a word of advice. In future, it might be wise to avoid gambling with the majority of your net worth. Is half a percent worth the possibility of going bankrupt when rates spike?
While treasury bonds are down, that doesn't mean the flight to safety hasn't occured. The Brazilian market is up and the price of a Brazilian utilty is up ~ 10%.
Exactly what Noah Yetter said: Discussions about the Fed managing inflation are about as useful, ultimately, as assumptions that the Fed is running a balanced equation. Or wants to. When every dollar is loaned into circulation to be reloaned some eight or ten more times, with each subsequent "dollar" incurring interest in, you guessed it, more loaned dollars, the problem is systemic.
Again: The Fed isn't running a system that can be balanced. The system currently in play is neo-Keynsian and nobody yet knows the endgame although the smart money is on insolvency.
There are entirely too many indicators fighting too many other indicators and all exist under what is now a nearly exponential M3 curve. It feels like positive feedback, which is instability with a destructive final phase.
By the way, there's a nice CPI graphic at The Mess That Greenspan Made.blogspot.com right now that puts things into perspective.
"Is half a percent worth the possibility of going bankrupt when rates spike?"
Who said anything about going bankrupt? I have plenty of assets besides my home.
That's why I can walk away from it.
Some of you people just aren't getting the big picture ... so let me spell it out for you again.
Let's take two people: me, and you.
You were "smart." You got a mortage for 6% for 30 years. I was "dumb" I got a 4.5% mortgage for 5 years, and then it's adjustable at LIBOR +2.5%, which is today ... voila 6%.
The Fed comes along and raises rates so that my mortgage is now 8%, or 9%, or 10%. What would you do? Well, I'm walking. I can't pay that. Nobody can. Fed didn't give me a choice.
So what happens next. I'm out my house, but you aren't off the hook, bub. The Fed just screwed you too guy. Because that house is going back to my bank, and my bank is dumping it on YOUR market, lowering the value of your house.
Meanwhile, I still have my other assets and my income, which I will use to survive by renting one of the very houses that the Fed's banks are dumping on the market.
The only drawback for me is that I probably won't be able to buy a house for 10 years. So, hey, it sucks, but since I have no choice, what else am I going to do.
You think you are protected since you didn't buy an ARM. But you're wrong. Interest rate increases will destroy your home value.
Ratewatcher,
I can't even imagine the circumstances that would need to obtain so that the fed "raising interest rates" could fuel a rise in CPI. Basically it seems your premise is that a rise in interest rates would cause everyone to stop producing things and because no one was producing things, they would become scarce and their prices would rise. But if this happened, interest rates would drop. The fed doesn't control enough money to have carte blanche to raise interest rates forever. At some point the currency would cease to be useful.
Why does anyone think that the Fed has the power alone to lower commodity and oil prices? With demand for oil coming from India, China, etc I don't think a modest reduction in US demand will be enough to lower the price of these commodities. Plus global supply is declining. The price of oil declined in the 80's because other producers of oil such as Mexico, North Sea and Russia broke OPEC's ability to limit supply. Those days is gone.
To John V,
"The Presidents were as much to blame for the rate as JR Ewing from Dallas."
John ... since I don't get to hire or fire the Federal Reserve Chairman ... guess who I take it out on?
Politicians decide whether ARMS are legal ... not the Fed. Politicians tomorrow could outlaw adjustable rate mortgages, but they haven't. The Fed, on its own, could prevent its member banks from selling them, and convert all existing ARMS to today's fixed rate.
These things COULD be done, but they aren't being done, because both politicians and the FED are blind to what's about to occur.
The Fed used to have the power to effect the rate of inflation by raising interest rates. It no longer has that power, because if it raises rates, the price I pay for my house just went up ... and far faster than a carton of eggs.
In the past, you could choose to NOT BORROW at those rates and people didn't for the most part. This slowed demand, and thus put downward pressure on prices.
Now, however, I can't choose to NOT BORROW at those new higher rates. I'm FORCED to pay the higher rate because of my adjustable rate mortgage. I have a new mortgage every year whether I want one or not, regardless of the price.
So, what's the effect? Prices just went up. Wait ... weren't we raising interest rates to fight rising prices?
So, you see ... as long as ARMs are allowed by politicians and the Fed to exist, the Fed is powerless to fight inflation.
The good news is: The politicians and the Fed could ELIMINATE adjustable rate mortages with one piece of legislation, in about 3 days.
But will they?
themightypuck,
I don't think you understand what Ratewatcher is saying. It isn't about producing "things" it is about interest rates and home prices. If interest rates on a 30 year fixed go up, home values will go down. Who wants to pay 8% interest on a 30 year fixed? Fewer people, which will lower the value of homes. Typically home sales rose and fell with interest rates. A few years ago interest rates were at historic lows, and the housing market took off. As interest rates rose, the market continued to soar, which was ahistorical and why a few savy market watchers saw a bubble and a crash coming.
Politicians tomorrow could outlaw adjustable rate mortgages, but they haven't.
I think Mass. outlawed ARMS in the state. Besides, no one is making new ARMS these days...
I think it would be a great thing if housing prices collapsed even further. Current prices are still too high imo.
BTW they would have to hold a gun to my head to get me to sign a variable rate mortgage. Lord have mercy.
FreddieMac has got it, sort of:
In the past, the Fed could raise interest rates, and it did not affect EXISTING homeowners.
That is no longer true. Today, 35-40% of all mortgages are ARMs. So, when the Fed raises interest rates today, it has a different effect.
It causes people to stop paying their existing mortgage ... rather than what it used to do which was to PREVENT them from ever getting one in the first place.
See the difference?
If you think today's housing crisis is bad, just wait for interest rates to hit 8, 9 10%. Massive numbers of people will be FORCED to walk away from their adjustable rate mortgages.
Game. Over. Baby.
Depression, soup lines, Steinbeck.
This former Fed economist is amused by the discussion of disaster should housing prices fall. How does falling prices change the productive ability of the economy? Does it mean houses disappear? Of course not. Since the number of houses won't change, and neither will our ability to produce other goods, a fall in house prices is simply a transfer from homeowners to non-homeowners. That is, it is the exact opposite of the transfer that has occurred over the last 6 or so years.
Also, concerning core inflation: as noted by a post above, core inflation can basically be thought of as "trend-smoothed" inflation. Historically, energy and food increase in price at roughly the rate of core inflation, but Q over Q or month over month they move around much more. When making policy, overall inflation is therefore difficult to use. But the fact that it is *difficult* does not mean that the Fed just ignores food and energy inflation! Not a meeting went by that we didn't look at overall inflation and its components. The people at the Fed aren't idiots. There is an article by Richmond Fed president Jeff Lacker (in the 08 annual report) about why overall inflation is important for policy, if you're interested.
Finally, I agree that rates should begin to move up. The PPI and import index numbers are far too high. At some level, there's not much we can do about things like energy and food: the Fed doesn't set ethanol policy. But still.
Megan,
The money supply growth of 10% plus on an annualized basis that has brought on the current inflation has stopped as of two months ago. M2NSA has shown zero growth for the last two months. Thus, the Fed may be two months ahead of your advice to them:
The Federal Reserve will have to clamp down, hard, to prevent high inflationary expectations from being written into contracts and labor agreements.
But, I wouldn't make a prediction on that since Bernanke is all over the place, which can result in embarassing forecasts, such as this one made by a female economics blogger in September:
Inflation is set about where it's like to be for the foreseeable future, fluctuating right around 2%
Bernanke is not kind to economic forecatsers.
Interest rate have three components "time cost of money", "risk" and "inflation". If inflation goes up, and it will, then interest rates will go up too. Nothing the Fed can do about it. They can try to lower the prime rate to 0% but who's going to lend you their money at 4% if inflation is 9%.
When inflation kicks in those people with variable loans are not going to be able to pay, which is going to bankrupt banks, which means they will have to be taken over and FDIC insurance paid out. On the other hand if the Fed raises rates the same thing happens. Guess what, paying the insurance is inflationary. That money was lent out already and it's gone so in order to pay depositors they have to print up more fresh cash.
This isn't about controlling an economy at this point. It's about chickens coming home to roost. Screwing with the currency has made the math not add up properly. Now it's only a matter of figuring out who gets screwed and by how much.
No we couldn't all retire millionares the way we thought we could during the internet bubble and lowering interest rates after it popped has only postponed the reckoning and made it worse.
Well actually we can all retire millionares in our 80s and with a dollar worth far less than it it's worth now.
Oh, did I mention all the foreign reserves of US dollars that will be flooding us.
t freddiemac, I got that part. And I understand ratewatcher's depression argument. I'm just saying that ratewatcher's statement that "Raising interest rates on the 35-40% of people who now own adjustable rate mortgages would ACCELERATE inflation massively." makes no sense to me. FWIW, I'd love low interest rates and higher inflation since I'm a net borrower whose debt cannot be discharged in a bankruptcy (student loans).
All,
My argument is that the Fed has neutered itself by allowing ARMs. It won't raise interest rates, because it can't raise interest rates.
Historically, when the Fed raised interest rates, it caused demand for homes to fall, thus, prices fell, thus wage demand fell. Eggs don't cause people to need higher wages. Houses do.
This is how the Fed, historically, combatted inflation.
Today, however, all it will do is cause banks to fail ... because today, people have ARMs. Today, if you raise interest rates millions of EXISTING BORROWERS, homeowners, will no longer afford their mortgage payment.
They do what humans do. They will stop paying.
Banks will then fail all over the country ... not just Schumer's bank. All banks. You do understand they don't have any money in their vault's don't you? You did listen to George Bailey, right?
What happens when banks fail?
Depression. Soup. Steinbeck.
http://en.wikipedia.org/wiki/Joseph_Schumpeter
I gather that you want a recession then. It doesn't matter, because recessions happen periodically. As to the 'reasons' for them, well, the economy is always cyclic, and alternates between boom and bust. In recent times, say the last 30 years or so, the peaks of the cycle (or at least the lows) have been much less extreme than in the past. For the time being, I'd ascribe that to our greater awareness of what underlies the economy.
The economy is probably the single most important issue to American voters this fall, which is ironic because the President has almost no influence over it. Despite the wishes of the left, the Congress can only harm the economy, not improve it. But the fact remains that whatever impact the federal government has on the economy is entirely in the hands of Congress, and the President can do f... all about it. (On the other hand, foreign policy is almost entirely in the hands of the President, and Congress can do f... all about it.)
You need to understand that recessions don't usually lead to inflation (unless Jimmy Carter or one of his clones is President). In almost all past recessions, including the Great Depression, deflation occurred, not inflation. Why do you suppose that gold was priced at $35 an ounce?
It would be nice if we gave up the euphemisms that seem to be de rigueur when discussing the economy. Both 'recession' and 'depression' are euphemisms for 'panic', which was the usual, and far more accurate, term used prior to the 30s.
It would also be nice if authors stopped implying that the stock market is representative of the economy. The stock market represents the economy in the same way that a mule represents the D-day invasion. You are free to ignore the good things that are happening all around you, but if you have any integrity whatsoever, you will not misrepresent the state of the world.
t Pink,
I have no idea why gold was "priced" at 35USD per ounce. I have some idea why the PTB "priced" gold but why they picked 35USD I haven't a clue. I think (but again, my econ mojo is weak) the USA went off the gold standard because of market pressure and the price shot up massively and immediately.
Only 1.1%? Megan, who shops for food in your family. And that "volatility" crap? Not on my planet.
For three pints of Breyers Ice Cream in these parts the SRP is $6.49, which is what it was for 4 pints of Breyers a couple years back. Can anybody spot the problem here.
Here's a hint. If Breyers was still selling half gallon containers you would be paying about $8.66 for one. People notice a change in prices, they tend not to notice a change in size.
BTW, Dreyes sells theirs for the same price, and at 7 cups instead of 6.
As inflation hawks go, I'm not particularly hawkish. I think moderate inflation is good, since it relieves the stickiness of nominal wages and helps the economy adjust to mild shocks.
Spoken like a true pseudo-liberterian who recently reread their Econ 101 text.
Why, oh why, can't Atlantic Monthly get better bloggers?
The political cynic in me says that the Fed won't do a rate increase until after the election.
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A declining dollar is good for a nation with way too much debt and a horrible trade imbalance. Is it not? I agree with whomever above suggested that the Gov't might actually welcome some inflation, although politically, its a big loser with the public.
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To the person who said they had a pension tied to the CPI and therefore wanted inflation. That makes no sense. if your income goes up at the same rate as the price level, your purchasing power is unchanged, ie your "real" income is exactly the same.
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Pink Pig,
You said a president can't do f*ck all about the economy, then a few lines later, blamed Carter for stagflation...but I don't want to get into an argument about that. Just pointing out the contradiction.
Ratewatcher's remark, "If the Fed raises interest rates above 2%, I, and millions of others, will simply stop paying for our homes and turn them over to the banks....When we stop paying our mortgages, this will destroy the value of YOUR home, as the foreclosures FLOOD your neighborhood, destroying the value of your primary inflation-fighting asset" illustrates why the Fed ought to strongly consider a firm rise in interest rates now instead of Volker-esque upward jolt later.
ratewatcher writes:
"Raising interest rates on the 35-40% of people who now own adjustable rate mortgages would ACCELERATE inflation massively (assuming it does not lead to a depression worse than what occurred in the 1930s.)"
In 2007 23% (not 35-40%) of outstanding single-family mortgages by value were ARMs (and larger mortgages are more likely to be ARMs, so the fraction of households with ARMs is less than 23%). See
http://www.ofheo.gov/media/marketdata/SFMOut90to07.xls
It is an interesting question if and by how much raising interest rates would raise inflation because of the presence of ARMs and the impact of higher rates on defaults that then need to be bailed out by the government.
The possibility that raising interest rates will raise inflation if the government faces unsustainable deficits (for instance by having to bail out the financial system) has long been recognized even by smart monetarists, see for instance
Sargent and Wallace, Some Unpleasant Monetarist Arithmetic (1981)
http://www.greatdepressionbook.com/research/QR/QR531.pdf
This them also showed up a lot in the East Asian Crisis of the late 1990s and other emerging market currency crises: here again raising interest rates often just blows out the banking system and eventually forces the government to print more money, the recognition of which drives up inflation immediately.
ratewatcher:
You say "We cannot pay 6%, 7%, 8%, 9% 10% interest on our monthly mortgages"
I don't know what your mortgage balance is, but at $200,000, 6% amortized is $1199 a month. At, say, 4.5% it's $1013.
So it's an extra $186 a month. $6 a day. Nothing. Pack a lunch and skip Starbucks. Eat a pizza at home instead of going out. Cut someone's grass. Sit your ass down at the computer for 10 minutes and ebay something.
Yes, it's a whack and a PITA, but for someone who has "plenty of assets besides my home," it should be manageable, especially since fixed-rate mortgages do still exist, you know.
Go get one. Pay the closing costs and the down payment with your "plenty of assets."
Of course, maybe your "plenty" is not the same as my "plenty."
You took the deal when you thought it was in your favor, but now you think it has turned against you, you want to bail, with the government FORCING it, and screwing up the mortgage markets for all time, as who with a brain is going to loan money in the future if the government can just change the damn deal on a whim?
And as for this:
"I'm FORCED to pay the higher rate because of my adjustable rate mortgage. I have a new mortgage every year whether I want one or not, regardless of the price."
Yeah, that's what you are FORCED to have, because THAT'S THE FRIGGIN' DEAL YOU SIGNED UP FOR.
Are you 13 years old or something?
Sheeeesh.
"Inflation is an increase in the money supply. It is NOT an increase in the price level, as the term was redefined."
Why this is irrelavent:
The money supply is not what is in print, but rather what is in circulation. When banks make loans, they increase the money supply. When the prices of things rise, their ability to be used as collateral also rises. This causes inflation of the money supply. When interests rates go up, the cost of borrowing increases, so less is borrowed against collateral. This decreases the money supply.
More dollars chasing the same goods and services result in higher prices. It doesn't matter if those dollars are borrowed or not.
"The Fed just screwed you too guy. Because that house is going back to my bank, and my bank is dumping it on YOUR market, lowering the value of your house."
Sounds great! My assessment's coming up, and I'm not planning on moving.
Banks will then fail all over the country ... not just Schumer's bank. All banks. You do understand they don't have any money in their vault's don't you?
Some (not all) banks will fail because they lent more than the sustainable worth of the homes. Let them fail. It will encourage future lenders to be a bit more careful and not get us into this problem again. The "value" of a house isn't gone, it's just lower than the peak. People will still want to buy homes at reasonable prices. Reevaluate the balance sheets, mark the losses, let the FDIC bail out the depositors if needed and let the economy move on from a new lower equilibrium price point for housing. Either that or give an automatic green card to any foreigner that buys a house.
Yes, that is what the stated point of the number is, but saying so doesn't make it so. Please see the New York Fed's paper at:
http://www.newyorkfed.org/research/staff_reports/sr236.html
Which says that the core rate is no better than a moving average of the whole CPI at predicting future inflation.
So, I return to my original point, which is that this number has no relevance to the world it is intended to model. It's a calculation without a purpose, hanging on out of habit.
Hi Chester,
The federal conforming loan limit is $417,000 ... not $200,000. Sheesh, what year do you live in?
I don't know where you live, but I live in the Northeast along with about 50 million other people. So, you can do that math and figure out what the average 3-bedroom 1 1/2 bath home cost here.
I will tell you that no new home within 100 miles of my job sells for below half a million dollars. To give you a better idea what I'm talking about, I will tell you that the 5,000 square foot LOT on which my house sits (50x100) is valued by my tax assessor at more than $200,000 ... with no house on it.
So, now get your calculator out and tell me you could afford a $400, $500 $600 $800 $1000 a month increase in your mortgage payment.
Maybe you can. Maybe you piss away that much money at Starbucks. I don't, and neither do most other Americans.
What we'll do is stop paying. It's just business, folks. I'm not willing to pay that much, so, I'll do what the law allows, and give the house to the bank.
Lots of smart people are doing the math and concluding that it's a bad business deal to continue to pay. It's not personal, its business.
Banks and other lenders seem unwilling to work with people to arrive at a mutually beneficial resolution, so people are bailing, taking the copper wiring with them and painting the house black from floorboard to ceiling as a going away present to Ben Bernacke.
Just business, you see. Don't take it personally.
KevDog,
thanks for the link. After posting here I also saw a paper by Nason who finds somewhat similar results.
http://www.frbatlanta.org/filelegacydocs/erq206_nason.pdf
One thing that may is going on here is that the recent US inflation experience has been so stable that there is just not that much information in the core and headline inflation series, and that inflation simply appears revert to a low level constant, with little information in current and past inflation, simply because monetary policy is successful at stabilizing inflation and the information content inflation time series for future inflation arises from monetary policy failures. But I've not looked into this question in any detail.
I'd still argue with your claim that Core inflation "has no relevance to the world it is intended to model" -- there may simply not be enough information in the data in the recent past to determine this -- not untypical for macroeconomic questions. The next few years may help decide this question.
I'd not be surprised if some other price series were better than headline and core CPI at predicting future inflation. Ang, Bekaert and Wei claim that expectation surveys dominate, but I've not read their paper, but the claim makes sense if the surveys are picking up actual expectations.
http://www.federalreserve.gov/pubs/feds/2006/200615/200615pap.pdf
Now if we just knew how to manage expectations...
So, now get your calculator out and tell me you could afford a $400, $500 $600 $800 $1000 a month increase in your mortgage payment.
I can! And with two kids and a stay-at-home wife with a law license to boot. I'd probably have to drop my 401(k) contribution, but I'd swing it. Hell, crank it up $2000/month, we can always send my wife back to work. And since I'm renting anyway...
It's known as "living below your means." You should try it sometime.
ratewatcher,
Man, I don't even know where to start.
People are not idiots. As rates go up, people will move into fixed rate mortgages. In your example data for interest rates show it took YEARS for the rates to go from 8.84 to 16.63. If your ARM adjusts once a year, people would move out of them pretty quickly I bet right before anniversary dates. For you to think otherwise is simplistic.
Zimbabwe - a country in East Africa where the government derivative formerly of a large part of popular feeling though perhaps not a majority thinks it can live with a severe case of 'ratewatcher' attitude
ratewatcher -
What do you want? To stay in the house you're in? Then refinance and get a fixed rate ... OR pay down enough principle that when the ARM loan adjusts it will keep the payment the same even if the interest rate rises. Or renegotiate the loan with the bank. Or walk, rent and then buy it again when the price falls and the bank tries to sell it.
If you can't afford those options, I recommend walking away and moving to the Southwest. Our home prices are falling steadily and with a 45 minute commute you can get a nice small home (for our region, generally larger houses than the NE) for under 100k or a large one under 200k. For what it's worth, I've got an ARM that will adjust in 2 years (I'm still at the "teaser" rate of 4.75%) and I'm not too worried about interest rates rising because the loan is capped at 9.75% even in the worse case, AND I'm saving money (no HDTV yet) and putting it into the principle payments now so my monthly payment won't rise when the loan does adjust.
ratewatcher:
"So, now get your calculator out and tell me you could afford a $400, $500 $600 $800 $1000 a month increase in your mortgage payment."
Yes, I could, as could a whole hell of a lot of other people. In fact I could pay off my house MULTIPLE times over FOR CASH. And that's with money my wife and I made ourselves over 20 years, not an inheritance.
I picked $200,000 because I live in a $300,000 house, well above the median for my part of the country and it seems like a reasonable figure.
You think 50,000,000 people in the Northeast all live in $500,000+ "new" properties? JH Christ on a stick!
If you can't live within your means as an adult, well, I'm sorry, but to hell with you and the horse you rode in on. Spend less, earn more, or move somewhere cheaper. Don't force me to bail your silly ass out when I have been living well within my means for decades, because I have some COMMON SENSE.
Advice: Don't get into adjustable-rate situations where a small PREDICTABLE blip against you will crush you like a bug.
It's too bad you apparently made A GIGANTIC COLOSSAL STUPID BONEHEADED HUNDRED-THOUSAND-DOLLAR MISTAKE, but maybe you've learned a lesson. Don't advocate that Congress should F up the entire nationwide mortgage market because of it.
Go live in a damn apartment like about 100,000,000 other Americans manage to do. And that's where you'll be for a long time when you default on your mortgage.
Ratewatcher. I suppose I was a bit harsh, but your comments really are a revelation; I don't know what I had been waiting for. The ideal of homeownership per, for instance my favorite dunce George Bush, that 'homeownership leads to people having a stake in society and their community,' obviously, as you point out, not.
KevDog:
KevDog writes:
"Please see the New York Fed's paper at:
http://www.newyorkfed.org/research/staff_reports/sr236.html
Which says that the core rate is no better than a moving average of the whole CPI at predicting future inflation."
Which means also means that core inflation isn't a bad predictor either compared to a correctly chosen MA of headline inflation. So at best this paper supports looking both at core inflation and headline inflation, not, as you suggest, that core inflation "has no relevance to the world."
My house, purchased 11 years ago, is appraised at over 2.5x what it was when I bought it (down from not quite 4x a couple of years ago).
That's still too high. I welcome the RE "crash". Sure, it lowers the value of my house, but so what? It's funny money anyway. If I'd tried to exploit the value of the house at its 4x value, I'd just be paying it back--or have moved into a house with a much higher assessed value and associated taxes. (Prop 13 is a big factor here.)
If the market drops by about 50% more, then we'll have a more reasonable increase of about 50% over a decade.
Of course, then, whatever it drops to, it'll spike again. At least, that's what's happened here the three previous times I've seen RE runs and crashes.
The ship may have sailed on this topic, but there's a big misconception I want to address.
First, I need to ask, to those here who are old enough: How were you doing economically in 1988? Were you standing in a soup-kitchen line? How about living in a shanty? Wandering through the dust-bowl looking for work? None of those things? Surely, then, someone you know was. No? I ask because if we suffered a drop in GDP equal to that of the Great Depression, that's where we'd be. YES, that is per capita. YES, that is constant dollars. 1988, folks. And to avoid this horrible possibility, we're prepared to implement all manner of absurd and dangerous "solutions."
For the last 15 years or so, we did anything we could to avoid even a mild recession. Inflation and moral hazard be damned. So now we have the pleasure of facing a possible depression as a result. I say if we manage to paper over this one, the next time around we'll be be talking about how we can't be worrying about the constitutionality of martial law when we're in a crisis!! The time for arguing about that is after the crisis has passed; we have to act now now NOW!!!
ratewatcher: Stop blaming the Fed. The Fed doesn't set mortgage rates. The market does. It is the very prospect of the inflation you seem to be pining for that will prompt lenders to demand higher rates from borrowers.
The Federal Reserve is only 1 lender among many. It has as much control over inflation as say a bank about its size.
If anyone can show me how the Fed controls inflation, how it controls interest rates, I shall be happy to forward $1000 US. I would supply a lot more, but I am a modest fellow.
Regards,
Gary Marshall
Gary,
I believe the Fed can reduce the reserves a bank must have as a percentage of the loans it makes--although one would expect that if the Fed reduced this number to (say) zero, there would be a run on the banks. The other thing the Fed can do is buy securities (which in my tiny brain seems to equal "print money"). Again, I suspect that this would be inflationary so that actual interest rates wouldn't be affected. That said, there seems to be a lot of empirical (or so I'm told) evidence that the Fed does have a significant impact on real inflation. I have a very linear grade 5 level A + B = C understanding of economics so I admit to a low level of confidence in my analysis.
Yes, the Federal Reserve can alter reserve ratios. However, it counts the currency member banks have in their vaults or atms as part of the reserve ratio. This has allowed banks to greatly reduce the money held at the Federal Reserve over time. But it is a way of possibly compelling increases in rates for member banks. But it will not bring rates down and it will have an effect only on member banks.
"Printing money" is a very interesting phrase. Any bank can print money through lending money, not just the Federal Reserve. So the Federal Reserve is hardly alone in printing 'loans' money. It does have a privilege, however. It is the sole issuer of $US currency. But the Federal Reserve would be loath to pay US goverment expenditures with currency. It would create inflation on a par with Zimbabwe where the difference between creating money through loans and creating money by printing currency is easily demonstrated.
There is a ratio between currency and the money created by loans. It is 1:22 approximately. When you print $1 of currency, you will create a further $22 of loaned money. So if you increase the amount of currency in circulation by $1, you will add $22 dollars to the money supply. Currency does not pay interest and the faster you can pass it along to someone else, the better off you will be.
Since creating such small amounts of currency is inflationary, the Federal Reserve cannot do it. It is contrary to its purpose. So to lend money, it must have money on hand to lend. In this, the Federal Reserve becomes just like any other bank with its power determined by its lending capability.
So how can such a puny lender control interest rates or inflation?
And believe me you are asking all the right questions. If only the monetarists were as deft.
Regards,
Gary Marshall