Fed Being Tempted Into SIN
Post from First Trust Economics Blog
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Aug 23rd, 2021
Narratives get more energy these days because of social
media and cable TV, but they’ve always existed. Back in the
1970s, one narrative was that inflation was not caused by too
much money creation by the Fed, as Milton Friedman argued.
Instead, it was caused by OPEC or “inflation expectations.” And
politicians came up with a plan…it proved disastrous.
In October 1974, with inflation running at about 12% (no,
not a typo), President Ford announced a plan to “Whip Inflation
Now,” which was supposed to reduce inflation, not by tightening
monetary policy, but by changing consumers’ habits.
Consumers were encouraged to wear “WIN” buttons.
The good news was that this approach was a more freemarket
method than the government-enforced wage & price
controls imposed under President Nixon. The bad news was that
by ignoring monetary policy as the ultimate source of inflation it
was destined to fail.
The theory behind the WIN campaign was that inflation
was caused by consumers spending too much money, so reducing
inflation required consumers to save more and spend less, by, for
example, growing their own vegetables, car-pooling, and using
less energy in their homes. The idea was that changing consumer
spending habits would wrestle inflation under control.
It’s easy to look back now and laugh at this absurd attempt
to reduce inflation. Alan Greenspan, who worked for Ford in the
White House, wrote in his book “The Age of Turbulence” that,
at that time, he was thinking, “this is unbelievably stupid.”
These days it appears the Fed has come full circle and is
trying to create more inflation. We decided to give the campaign
a name : Start Inflation Now. And maybe the Fed should print
some SIN buttons.
That, in a nutshell is the policy proposal published by David
Wilcox, a former influential research director at the Federal
Reserve, and David Reifschneider, a former Fed economist and
adviser to Treasury Secretary Janet Yellen (who backs the
reappointment of Jerome Powell).
In particular, Wilcox and Reifschneider want the Fed to
raise its 2.0% inflation target to 3.0%, which would let the central
bank run a looser monetary policy. They believe this looser
monetary policy would help create more jobs, reduce
unemployment, and even reduce racial inequities.
We think consistently higher inflation is a bad idea.
Printing more money is not a path to sustainable prosperity.
Higher inflation would make business planning more difficult
and reduce the “real” (inflation-adjusted) wages of workers,
particularly those with the least bargaining power, including
Nevertheless, we think a higher inflation target is being
discussed internally at the Fed. What this means is that even
though the Fed is talking about “tapering,” it is highly likely to
maintain a far easier monetary policy than what otherwise is
warranted. Even if the Fed moves toward tapering its bond
buying, short-term interest rates will still be near zero. The Fed
is still going to be loose even when QE is done.
For now, the Fed still says it expects inflation at about 2.0%
next year as well as in the years beyond. We think inflation will
be higher than that next year and, if the Fed doesn’t explicitly
reject the idea of a new higher 3.0% target, may be higher for
many years to come.
Money is a contract between government and the people.
A stable currency is essential for a stable economy. With the M2
measure of money now 33% higher than it was in February 2020,
total spending – prices plus real output — will end up 33% higher.
That doesn’t mean a 33% increase in the CPI; after all
productivity is growing. But this is more extra money than the
US economy has absorbed since the 1970s. We may have more
than one book written by advisors in DC today that echo what
Alan Greenspan thought back in the 1970s.
Narratives work for political entities in the short-run, but
often lead to disastrous outcomes over time. We will be
watching the new SIN policy closely in the years ahead.