Garrison on Bernanke and What to Expect from the Fed

Two days ago I discussed some of the implications I took from Ben Bernanke's recent speech at a monetary policy conference at the Federal Reserve Bank of Boston. The same day Roger Garrison, professor of economics at Auburn University had an excellent article explaining his take on what Bernanke said and what it all means. I'm happy to see that Garrison agrees with me while his treatment is more exhaustive. Garrision hits the nail on the head when he notes

Ironically, Bernanke argues in favor of deliberately creating a 2 percent inflation rate in order to be able to respond in conventional ways should a recession threaten. There seems to be no recognition that a Fed-engineered inflation and the resulting market distortions, especially the interest-rate distortions, are precisely what cause a recession to threaten. Or that true price stability might entail a pattern of prices, wages, and interest rates brought about by the market in the absence of monetary manipulation by the central bank.

Miller on the Lack of Free Lunch for Health Care

My friend and colleague Tracy Miller has another excellent blog post on the implications of reality for health care provision. The facts of life are such that all economic goods, including health care, are scarce and therefore producing and obtaining them necessarily incur costs. This fact is due to the nature of the created order and can not be wished away by policy makers by fiat.

Miller received an email from the daughter of our Congresswoman who voted for ObamaCare. 

In the email she explained that because of Health Care Reform, which her mother supported, she no longer had to pay a $25 co pay for each prenatal appointment. This will save a family “that lives paycheck to paycheck” over $500 per year. Such savings makes healthcare reform sound like a wonderful gift until you stop to reflect- who pays the $25 that the consumer no longer has to pay each time she visits the doctor? The answer: for those who have health insurance, the elimination of copayments will mean higher premiums. In other words, paychecks will become smaller as insurance rates rise to cover this new government mandate.

The point is that whenever a good is provided, someone has to pay the cost. No scarce goods are ultimately free.

Ben Bernanke, Inflationist

I have previously commented on Ben Bernanke's views of monetary theory and policy here, here, and here, noting that his forecasting track record is less than stellar, his troubling (indeed dangerous) monetary policy follows from bad economic theory, and that his overarching vision is driven by a fear of deflation.  His remarks Friday at a monetary policy conference at the Boston Fed, however, reveal that his deflation phobia has progressed to the point that he is no longer merely worried about deflation, but also about insufficient inflation.

 His comments reveal the extent of Bernanke's commitment to inflation and also the problems faced by a central money creator charged with a dual mandate that is often internally in conflict. As Bernanke notes in his speech, the Fed is charged by Congress to work to maximize employment and price stability. Over the course of the 2000s the Fed repeatedly held interest rates too low as a means to keep unemployment low. It appeared to work for awhile as unemployment did stay relatively low and at the same time there was not much increase in the CPI. Notwithstanding the tremendous increase in the prices of equities and houses, it appeared to many that the Fed had successfully continued the Great Moderation.

Unfortunately, as Misesian economists predicted, massive inflation of the money supply via credit expansion leads to massive capital malinvestment, which necessarily results in a recession, the effects we are still painfully enduring. Bernanke has responded as expected by pouring tremendous amounts of reserves into commercial banks to the extent that the Federal Funds rate remains at an all time low.

Bank Reserves Increased to an All-time High

The Federal Funds Rate is Still at an All-time Low

Now, however, Bernanke is concerned he has inflated himself into a corner, because rates are so low, he is worried that he may have hit a limit in how effective conventional monetary policy can be. Never mind that the prices of stock equities and commodities are on the rise as well as important sectors of producer prices. The fact that the CPI is not rising fast enough to create inflationary expectations so that an inflation premium is not being added to market interest rates constrains the effectiveness of expansionary monetary policy. The way to combat the scourge of prices not rising enough is to pour more money into the economy. Bernanke is no longer merely a deflation-phobe. He is a not-high-enough-inflation-phobe.

What Malinvestment Looks Like: Aerial Photo Edition

Thanks to Greg Ransom for posting a link to these stunning photos of Florida real estate malinvestment on the Mises Economics Blog. They provide literal pictures of capital consumed in projects that could not be completed due to entrepreneurs being led astray by the strange woman of artificial credit expansion. As the original post states:

The images of half finished (and barely started) developments are strangely beautiful, with a geometric symmetry that belies the state of human misery these developments represent: Lost deposits, bankruptcy, mis-allocated capital. 

Appropriately, Ludwig von Mises used the analogy of a builder to explain the fundamental nature of the malinvestment that causes the business cycle. Entrepreneurs are led astray by artificially cheap credit to undertake investment projects for which there is not enough real capital goods to bring all of them to completion. Many of these projects will fail, with some ending in bankruptcy. In Human Action Mises likened the situation to a builder who tries to build a building with too large a foundation, only to realize much later that he does not have enough bricks to complete the building.

The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal.

These pictures illustrate one hundred and eight words.

Who Benefits From Inflation? Those Who Get the New Money First

In my op-ed on the immorality of inflation I explain that one of the ethical problems of state increases in the money stock is that it redistributes wealth. Those who receive the new money first are able to use their higher real incomes to purchase more goods. However, over time overall prices rise so that those who get the new money later find that the amount of new money does not offset the rise in prices. Additionally, those people on fixed incomes do not see a dime of the new money, but must pay the higher prices nevertheless.  Those who get the new money first benefit at the expense of those who get it later or not at all. In our current system, those who get the new money first are those closely connected to the banking system and the state.

The Federal Reserve creates cash reserves that serve as assets for commercial banks. Much of this new money is presently being spent on treasury bonds. This demand for Treasury bonds makes it easier for the government to borrow this new money to cover its spending above tax revenues. That is why one of the only sector where hiring is on the rise is the government.

This analysis helps explain why Manhattan, Kansas is weathering the Great Recession in relatively fine fashion. It is home to Army base Fort Riley. Therefore there is a lot of new money floating around. The result is that per capita income in Manhattan rose 4.8 per cent in 2009. As Business Week explained it,

Wealthy individuals remain concentrated near large cities with business and finance hubs, but William H. Frey, a Brookings Institution demographer, says state capitals, military towns, and college towns also often have higher-than-average incomes due to their ability to survive economic downturns, as their main industries are buffered by government-related funds.

This comes, of course, at the expense of people who live elsewhere and, hence, get the new money later or not at all.

On World Food Day: Desrochers and Shimizu on the Local Food Activist's Dilemma

Today is World Food Day. In reference to this year's theme "United Against Hunger" Pierre Desrochers and Hiroku Shimizu have written an excellent blog post documenting the problems associated with the "food miles" fetish of many locavores. They write:

. . .in a world where no good deed goes unpunished, the individuals most responsible for producing ever-growing amounts of food at ever more affordable prices – from large scale farmers, professional plant breeders, synthetic pesticide and fertilizer manufacturers to agricultural equipment manufacturers, commodity traders, logistics industry workers and packaging manufacturers – have increasingly been demonized as poor stewards of the Earth, if not outright public health threats.

I've written about this before and am happy to see I am in agreement with these experts who have written extensively on this topic.

Thomas Woods on Warren G. Harding and a Forgotten Depression

Historian Thomas Woods has written an article that everyone should read. In "Warren Harding and the Forgotten Depression of 1920," Woods tells the story of how Warren G. Harding responded to the economic depression of 1920 in such a way so that we never hear of the Great Depression of the 1920s.

Instead of Harding and Congress heavily intervening the the economy via government spending and borrowing, the market was, by and large, allowed to liquidate capital malinvested during the previous decade. Woods draws upon speeches by Harding documenting the economic cogency of Harding in the face of a sharp recession. Along the way, Woods provides one of the best, most concise, explanations of the business cycle according to Misesian economic theory. Woods concludes:

Harding’s inchoate understanding of what was happening to the economy and why grandiose interventionist plans would only delay recovery is an extreme rarity among twentieth-century American presidents. That he has been the subject of ceaseless ridicule at the hands of historians, to the point that anyone speaking a word in his favor would be dismissed out of hand, speaks volumes about our historians’ capabilities outside of their own discipline.

The experience of 1920–21 reinforces the contention of genuine free-market economists that government intervention is a hindrance to economic recovery. It is not in spite of the absence of fiscal and monetary stimulus that the economy recovered from the 1920–21 depression. It is because those things were avoided that recovery came. The next time we are solemnly warned to recall the lessons of history lest our economy deteriorate still further, we ought to refer to this episode—and observe how hastily our interrogators try to change the subject.

Woods' piece is indeed an excellent tonic for those who presume that an economic contraction requires a state-induced activist solution. All who wish to better understand the economic history of the 1920s and business cycles in general should avail themselves of this outstanding contribution.