Jim Devine
Fri, 27 Aug 2010 13:12:47 -0700
> Long-run monetary neutrality is an uncontroversial, simple, but > nonetheless profound proposition. In particular, it implies that if > the FOMC maintains the fed funds rate at its current level of 0-25 > basis points for too long, both anticipated and actual inflation have > to become negative. Why? It’s simple arithmetic. Let’s say that the > real rate of return on safe investments is 1 percent and we need to > add an amount of anticipated inflation that will result in a fed funds > rate of 0.25 percent. The only way to get that is to add a negative > number—in this case, –0.75 percent. The problem with this fellow's analysis is that the current situation belies the NC concept of the long run. That idea assumes that the economy will attain something like full employment in the foreseeable future. (It isn't full employment from labor's point of view, but from capital's, so that the unemployment rate is relatively high.) It's only at this full employment that the real safe rate is relevant. When and if we attain that situation, we won't see a fed funds rate equal to about 0.25%. It would be more like 4%, in which case a 1% safe rate would correspond to about 3% expected inflation (for loans of similar maturity, i.e., overnight). In a deep recession, the fed funds rate approximates the safe rate, in nominal terms. That is, if the Fed is loaning out at 0.25%, a bank can feel safe lending out at about 0.25% and financiers will have similar views concerning the required nominal yield on short-term bonds. If we're expecting 1% inflation, then the real safe rate equals approximately -0.75%. That sounds bad, but it's better than the real rate of interest on holding money, i.e., -1%. The arrow of causation goes in reverse from the situation in the hypothetical long-term equilibrium. (If we're expecting -1% inflation, i.e., mild deflation, the safe rate equals approximately 1.25%.) -- Jim Devine / "Segui il tuo corso, e lascia dir le genti." (Go your own way and let people talk.) -- Karl, paraphrasing Dante. _______________________________________________ pen-l mailing list pen-l@lists.csuchico.edu https://lists.csuchico.edu/mailman/listinfo/pen-l