Wednesday, April 15, 2009

Prices are down. That's good. No, it's bad...

From the AP:
Consumer prices dipped unexpectedly in March, leaving inflation over the past year falling at the fastest clip in more than a half-century. The recession is expected to keep a lid on inflation as widespread layoffs dampen wage pressures and weak demand keeps companies from raising prices....It was a better performance than the 0.1 percent rise in the Consumer Price Index that economists had expected.
So that's great news, right? "Better" performance?

Maybe not:

Over the past 12 months, core inflation has risen 1.8 percent. While some economists have expressed fears the recession could spawn a destabilizing period of falling prices, other analysts point to the rise in core inflation as evidence that deflation remains only a distant threat.

In fact, some economists worry that all of the moves the Federal Reserve has made to fight the recession and the worst financial crisis in 70 years could be sowing the seeds for inflation troubles down the road.

Well, that actually sounds pretty dire. I'm getting a little confused as to whether we have deflation or inflation, and whether we have good news or bad. If only some learned fellow could put my mind at ease:
In a speech Tuesday, Federal Reserve Chairman Ben Bernanke repeated assurances that the central bank is always mindful of the threats of inflation and is prepared to remove the monetary stimulus it has provided once the economy shows signs of stabilizing.
Oh, OK then. The central bank is on top of it, and will suck all the money out of the economy, the billions and billions of dollars, once there are "signs" of things going better.

Sarcasm aside, we need to be very afraid of this. There are two massive forces colliding, one deflationary as wages and prices are cut, the other inflationary, as the Fed pumps money into the economy. As long as they remain roughly in balance, we'll see only mild price changes.

If we listen to the Chairman, we would believe that the Fed is so thoroughly attuned to the health of the economy that it will know exactly when things are turning around and will remove "monetary stimulus." This is code for money supply and interest rate changes (those are the two monetary tools the Fed has at its disposal).

This is the same Fed that did nothing to curb a tech boom 10 years ago, and did nothing to curb the housing boom of these past several years.

More importantly, monetary policy is not what we're using to put people to work and get the economy moving. We're using fiscal policy, as the government shovels money out the door to soak up all that unused supply of labor.

However, the stimulus money, quite a bit of it, has been marked for long-term projects, infrastructure improvements, just as all the economists and pundits told us it should be. These projects, despite the use of the term "shovel-ready," tend to take a certain amount of time to wind up, and they also are predominately atomic (that is, a single indivisible unit).

For this kind of fine tuning to work, we had better be prepared to see roads to nowhere, bridges half completed, wind farms abandoned...but we know that's not going to happen. Even after the economy starts to turn around, we're going to be committed to finishing these projects, and that will cause distortions in the recovery - even, potentially, more bubbles. We could very easily end up lurching back and forth from boom to bust, never quite getting a handle on doing things that lead to long-term growth and stability. And I don't even need to mention the political swings that will come about.

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