Sunday, July 28, 2013

Sumner & Soltas on the Fed & Business Cycles

There's a lot of wisdom there, including the comments, with George Selgin coming in at clean up.

Falling investment is the problem in recessions, not falling consumption.

Falling interest rates would normally be a sign of a structural problem, and the effect of markets adjusting to lower investment return expectations.  So the Fed tends to follow the rates down, but communicates as if it's leading the parade, so we end up with tighter money than we should have in the Fed's absence, but conventional wisdom is that the Fed is loosening.

Rates have been in a long term secular decline, which is mostly due to demographic and long term economic changes, and if the Taylor Rule doesn't account for this, then the Fed will inevitably tighten too often so that we end up with the double whammy of low real rates and low inflation.  If the Fed doesn't account for this, we are likely to be back at the zero bound when the next recession comes.

Especially with our screwy way of accounting for health benefits, with real interest rates being very low, a 4-5% inflation target would probably be better than the 2% targets we have been at.  Of course, it would be even better if we could somehow get some structural improvements in health care spending.

Those are my thoughts.

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