Reflation: Stimulus From the Fed

Appar­ently there are decent econ­o­mists over at the Fed. Ezra:

In a recent speech at the Fed­eral Reserve Bank of Boston, Bernanke made per­fectly clear that the cen­tral bank is tired of watch­ing the econ­omy stag­nate. “With an actual unem­ploy­ment rate of nearly 10 per­cent,” he said, “unem­ploy­ment is clearly too high” — and, yes, the ital­ics are in his pre­pared text. So the Fed­eral Reserve is likely to begin pur­chas­ing Trea­sury bonds — “quan­ti­ta­tive eas­ing,” it’s called — in an effort to lower inter­est rates and spur the econ­omy. They did this in 2009, and to great effect.

But inter­est rates can’t go any lower,” you say. This is true in the sense that nom­i­nal rates have hit the zero bound, but the pur­pose of quan­ti­ta­tive eas­ing is to sys­tem­at­i­cally reduce the value of cur­rency rel­a­tive to real goods such that the real inter­est rate heads neg­a­tive. In other words: refla­tion.

Refla­tion encour­ages busi­nesses to get out there and spend their money, because oth­er­wise the value of their cash hold­ings falls as infla­tion returns to nor­mal val­ues. One type of invest­ment that is rel­a­tively safe is the TIPS, or Trea­sury Infla­tion Pro­tected Secu­rity. So if peo­ple are will­ing to pay more for these bonds, then we can assume that their desire to hold cash is low. NYT (via):

Bizarre as it sounds, that is cor­rect. In an auc­tion of a spe­cial kind of five-​​year Trea­sury bond, investors paid $105.50 for every $100 of bonds the gov­ern­ment sold — agree­ing to pay the gov­ern­ment for the priv­i­lege of lend­ing it money.

This is good news — it means that investors believe the Fed will really fol­low through and print enough money to reflate the econ­omy. Other Fed pres­i­dents are rein­forc­ing that per­cep­tion (via):

If we could guar­an­tee 5% [nom­i­nal] GDP growth per year for sev­eral years, it would be great.

The “nom­i­nal” in that state­ment implies that, even if real GDP stayed the same, infla­tion would be 5%. The impli­ca­tion is that the infla­tion would really be refla­tion, dri­ving real GDP growth back to nor­mal. But it only really works if peo­ple believe it, since oth­er­wise prices won’t change at all.

Let’s hope it works.

(photo: AZRain­man)