Why does the Fed have a mandate to insure 2% inflation. Perhaps the better question is who benefits from inflation. The average Joe 6pack has no savings, rents an apartment, leases his truck, owns no assets, no stocks. He gets his paycheck and spends it. He wants lower prices. When gas goes below $2 he's happy. When beer goes down he's even happier, and the more he drinks the happier he is and the more he saves. Who wants higher inflation? Big debtors. Who is the biggest debtor: US govt. Who has the most assets at the most leverage: Big banks.

Orson Terrill writes: 

I disagree with the Feds own explanation, and I think many economists would too.

The Fed doesn't have a mandate for any target rate, and the dual mandate puts employment at odds with inflation. Their stated concern about falling wages is disingenuous.

While they talk about falling prices, the fact is that the Fed is powerless if rates hit zero and deflation persists. The Fed wouldn't have control over the money supply or the economy. Though there are experimental tools that could be used.

The Fed will never say they are powerless. That creates a game theoretic situation where in deflationary panics The Fed could lose credibility in the markets, and deflation with rates at zero could become a Suboptimal Nash Equilibrium.

Why 2%: There's not really a good reason, and what the the Fed published is moronic….

Theoretically, you can have very stable 10% inflation target, and life would be no different than at 2% inflation target, because REAL prices would be same, so as long as inflation expectations were stable. Most monetary economists would probably agree with this….

Gordon Haave writes: 

There are two things going on here really:

The first is the idea that price stability is a good thing in that it aids in long term decision making. The most important point though is the fed view that deflation is a bad thing. The origin of that line of thinking is the Keyensian notion that the market for labor doesn't clear because wages are sticky.

To elaborate: Classical economics would dictate that you would never have ~25% unemployment because the price of labor would fall until it hit equilibrium. However Keynes said that during the great depression this did not happen because wages are "sticky". Due to contracts and other things the price of labor does not fall. Hence, to reach equilibrium the government needs to stimulate demand. There is at some level some amount of truth to the "Wages are sticky proposal" however the cure is much worse than the diseases. The primary policy of both the fed and the federal government is to prevent markets from clearing at all. Hence, when homes are overbuilt and a crash occurs the powers that be actually think that building more houses is a good idea.

The reason for this is the second reason why the fed targets 2% inflation: The idea that deflation is a bad thing. Main stream economists believe that if the economy enters a general deflation that it will enter a "deflationary spiral" where prices will keep going down. Under this theory nobody will ever buy anything because why would you buy something if you know the price will be less next year?

A funny thing is that the Keynesians like to scoff at "Austrians" and other free market theorists for having ideas that don't hold up under scrutiny yet the deflationary spiral nonsense is easy to examine.

First: We know that flat-screen TV prices have gone down every year for the past 15 years. Yet, is it the case that nobody bought them because everyone knew that they would be lower the next year? So, with that one example alone we already know that the entire theory is bogus.

2nd, the deflationary spiral theory poses that basically there is no way out of it. Yet, society still exists as a whole despite many bouts of deflation, so we know that the markets have a way of righting themselves.

This entire theory explains the seeming disconnect between GDP numbers and how the average person sees himself in the economy. In order to keep housing prices up, for example, millions of homes were being built due to false price signals by the Fed while millions of homes sit unoccupied. Everything is being done to keep markets from clearing.

When markets are not allowed to clear and prices not allowed to fall what you get is what currently exists in Japan - the death of civilization as young people, priced out of marriage, home ownership, children, etc. simply check out of society. It is coming here.


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