Dan has suggested that we toot our horn about our criticisms of Fed policy over the past couple of business cycles. We think we got that mostly right. I’ve refrained, because we didn’t get some other things right, and in this business it is a certainty we will be wrong at some point. We’re here to present our point of view. We hope people look at many points of view and make their own decisions.

Bill

Well I definitely see this line of thinking pervasive in the actions and justification of current monetary policy. The dreaded deflation must be stopped at all costs.

My one point is.. If you truely believe that.. you better be very right on your regulation and monetary policy to prevent large asset bubbles, especially those financed by the mechanisms that are the lifeblood of credit into the economy. Because if your policy is wrong, you get exactly what we have now, A lot of bad decisions trying desperately to prevent deflation and rewarding inefficient economic behavior.

Central banks are so powerful that they have to be very right (and I would think, very conservative) because the lag between being wrong and realizing it is long and the consequences are great. All it takes is one Greenspan-esque person to throw the whole thing for a loop. Reinterperting and lobbying for the repeal of Glass Steagal, fighting reforms of derivatives before they became the monster they are today, keeping monetary policy too loose for too long, etc.

I am a case in point where asset price inflation discouraged my demand (in particular homes and in some case, equities).When the numbers stop making sense rational people either have the choice to become irrational and join the malinvestment or withdrawing their demand. Prices of homes falling make me more likely to buy not less likely.

Thank you for reading our blog. I’m glad to hear you don’t have an agenda.

I still think you should use the absolute value.

I disagree with you on the idea that the source of deflation matters. Deflation discourages demand and is unequivocally bad, even in small amounts, regardless of cause. I would be a lot more sanguine about our economy right now if the CPI was a positive 1.3 instead of its current negative 1.3.

While I’m at it, I don’t believe the Fed is actively contracting the money supply, but monetary policy is not unambiguously expansionary. The money multiplier began its dramatic decent, and bank loans peaked, last October. It is no coincidence that last October was when the Fed began paying interest on excess reserves.

Scott Sumner presents what I consider the most thorough analysis of Fed policy at his blog. I recommend it:

http://blogsandwikis.bentley.edu/themoneyillusion/

Thank you,
Bill

We did look into using the absolute value of CPI (also PCE and the absolute value of PCE) and the only time the CPI was negative since 1967 has been March 2009 – today. Other than that the graph is identical. We are not trying to say that this economy is the worst since any particular year, nor is there any agenda attached to the number.

Secondly, we take issue with the idea that deflation is worse than inflation. There are two types of deflation. Artificial deflation is when the Fed actively shrinks the money supply. The Fed created artificial deflation in 1929-1932 under the Real Bills Doctrine. This type of deflation is bad. However, the Fed has not been contracting the money supply! Falling prices are necessary for the liquidation of malinvestments to occur. The liquidation of malinvestments are necessary for realigning the capital structure. Without that realignment, then there is no chance for a real recovery.

Thus, we kept CPI in as is. If there is a point in time where the Fed is actively contracting the money supply, then I suppose we’ll have to revisit this issue.