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https://seekingalpha.com/article/4694307-how-fed-c...

Tend to agree with Jim Sloan from his recent piece in Seeking Aloha. His data reveals long term inflation is closer to 3.3%, so why shoot for 2%?! Excerpt:

“As for rate cuts, I don't get the discussion at all. Why would the Fed do that? The economy has been doing fine with a few signs recently that it might slow a bit or have at worst a brief and mild recession. To worry about anything more than that would require new information. Rate cuts serve mainly as a cure for a weak economy. Does the Fed really want to give up the dry powder provided by a 5.33% Fed Funds rate? The Fed should be happy with 3% inflation accompanied by high quality bonds yielding 4.5%. Those are the best numbers we have to describe a long term "normal." These present numbers work well enough for most savers and investors who have just emerged from a world in which safe income has been very difficult to find. Consider the current rates as the potential source of dry powder when new numbers on the economy suggest that rate cuts may actually be needed.“

I certainly don't argue with the notion that historically average US inflation rate has been somewhat above the Fed's 2% target.
Since 1925, the start of my usual data set, the median rolling year has been 2.65%, and the average rolling year has been 3.03%, and the compound rate has been 2.95%.
But: so?

There is this yawning chasm of logic whereby the writer suggests that the central bank's target should equal the historical average. Why? The 2% target taken by the Fed (and a number of other central banks) is chosen because they think it best serves the long run stability and prosperity of an economy. It's arrived at by starting with price stability, but then adding just enough slippage to help with the real problems caused by nominal price stickiness. Neither the target number, nor the logic behind its selection, has anything at all to do with what has been typical in the past. The economy was manifestly broken in the past during (and due to) some times of very high (and occasionally very low) inflation, so those are not good samples to include in what you want to aim for.

My historical average weight is not the same as my target weight, for much the same reason : )

Jim

The 2% target taken by the Fed (and a number of other central banks) is chosen because they think it best serves the long run stability and prosperity of an economy. It's arrived at by starting with price stability, but then adding just enough slippage to help with the real problems caused by nominal price stickiness.

Not really. It was actually invented in NZ.

More than 30 years ago, some relatively youthful central bank and Treasury economists in New Zealand were grappling with how to bring two decades of double-digit inflation under control in an economy less than 1% the size of its U.S. counterpart.
What if, they asked, they just told everyone the rate should be much lower - say roughly 2% - and then aim for that?
"It was a bit of a shock to everyone, I think," said Roger Douglas, the Labour Party finance minister at the time who worked with the Treasury and Reserve Bank of New Zealand (RBNZ) to pioneer the policy. "I just announced it was gonna be 2%, and it sort of stuck.

Like that, inflation targeting was born."


https://www.reuters.com/markets/mouse-that-roared-...

Not really. It was actually invented in NZ.

That's why I said "and other central banks". They all did it for the same underlying reason.

Some fairly serious people think a 3% target might work better. But that's because they think it would solve the sticky-price problems a bit better, not because it has anything to do with historical inflation rates.

Jim

Why? The 2% target taken by the Fed (and a number of other central banks) is chosen because they think it best serves the long run stability and prosperity of an economy. It's arrived at by starting with price stability, but then adding just enough slippage to help with the real problems caused by nominal price stickiness.

I've read that the reason the Fed continues to expand the money supply in not only bad times but also good, aiming to keep the economy in a state of slowly rising prices, is because deflation is seen as enemy #1. And the deflationary spiral that can occur in severe recessions, like the Great Depression, does seem like a dreadful thing worth avoiding.

But what's less clear to me is why fighting deflation in a healthy, growing economy is beneficial. It's been said that normal deflation in a healthy economy would discourage spending on goods, as people may choose to wait for prices to drop further to spend. But part of me wonders how bad a thing that would be, especially today given the incredibly low savings rate we have in the US. And presumably, a good chunk of money not spent would likely be put to work through investments rather than sitting under a mattress idle.

Is anyone aware of an example/case study of a country that did not expand their money supply at all during healthy economic times except to step in to stave off deflationary spirals during severe recessions? I'd love to read about it.

Is anyone aware of an example/case study of a country that did not expand their money supply at all during healthy economic times except to step in to stave off deflationary spirals during severe recessions? I'd love to read about it.

I think it's more about asymmetrical risk. Deflation is more dangerous than inflation. Perhaps better would be to look for examples that a country slipped into deflation and couldn't get out, and the economy had real problems. There are several such examples.

Fortunately, there are tools that will bring inflation down. Draining liquidity in a variety of ways, usually starting with higher interest rates, but perhaps also including changes to bank reserve requirements, QE, twist, tax changes, etc. Some of them are painful, but they do work.

However it is maddeningly difficult to get an economy out of deflation. This is very surprising...it would seem to be the easier problem--surely helicopter money would do it? But in the real world it seems not. Once the pervasive *mood* of deflation sets in, a country's economy can get really stuck in the muck.

Given the asymmetrical risk, it makes sense to target a positive number rather than zero or a slightly negative one. (a positive number has other benefits too, but this is just the deflation-avoidance reason).

Jim

<<As for rate cuts, I don't get the discussion at all. Why would the Fed do that? The economy has been doing fine>>>

Because the present Fed policy is stimulative.

Imo this isn’t your grandpa’s economic cycle lol. Americans have become CREDITORS who make MORE money from higher rates. The Fed is indirectly pumping $Trillions into savings accounts and money markets..balances compounding at 5.25 risk free no duration. Meanwhile the BORROWER, Uncle Sam—PAYS MORE which raises its deficit—for what purpose? To grow the $6.2 Trillion sitting in money market/passbook savings? While freezing out a generation of new potential owners who can’t buy a home because inventory is frozen by unwilling to part sub 4% locked in fixed rate owners?

These are not new dynamics,obviously, but the effect is somewhat unique due to the Pandemic which put $Trillions in emergency “aid” in people’s pockets—folks largely fully employed and void of large expenses like transportation, day care etc. So we have this sort of unprecedented liquidity bubble that created millions of debt creditors being paid triple the “normal” 2010s rate to be short term lenders to Uncle Sam. All that cash is bankrolling huge spending levels in a nearly 6% nominal GDP environment: I think the top THREE travel days all time are this month…

Uncle Sam is unnecessarily raised its debt, freezing out young homeowners, AND stimulating the economy by fattening checking accounts.

" Americans have become CREDITORS who make MORE money from higher rates."

https://www.marketwatch.com/guides/banking/america...

" Americans have become CREDITORS who make MORE money from higher rates."

Some have, but your link says this:

https://www.marketwatch.com/guides/banking/america...

Americans Are Carrying Record Household Debt into 2024
U.S. household debt grew by $800 million from 2022 to 2023, including a 16.6% growth in credit card debt.

While the new year marks a time for new beginnings and a fresh start, millions of Americans entered 2024 with more debt and less to put in their checking and savings accounts. At the start of the year, U.S. household debt reached a record high of $17.3 trillion, according to data from the Federal Reserve Bank of New York (NYFRB).

I'm personally enjoying these higher rates, and also through Berkshire.

Looks like a lot of Americans aren't enjoying them so much.

" I'm personally enjoying these higher rates, and also through Berkshire.

Looks like a lot of Americans aren't enjoying them so much."

Good morning, yes, some of us are very lucky financially and hopefully healthy. I retired from the business in 1992 but friends and their kids kept in close touch. Many kids just can't or won't talk finance with their own parents ,lol. They have IRAS, 401ks, 529s, they lived within their means, but, I'm getting calls from people struggling to stay off the credit cards, aka, financial poison!! As you well know, costs are exploding, insurance, food, maintaining our homes, etc, that's reality 101. My bills are all on auto pay on my Costco credit card so maybe I wouldn't even notice it, but the other 200 million Americans feel it bud. This isn't sustainable for the masses, good people working 40 hour weeks should not be struggling to survive in America. Stay well.

>>Americans have become CREDITORS who make MORE money from higher rates."

Some have, but your link says this:

https://www.marketwatch.com/guides/banking/america...

Americans Are Carrying Record Household Debt into 2024
U.S. household debt grew by $800 million from 2022 to 2023, including a 16.6% growth in credit card debt>


LOL. It goes both ways, yes! Problem is for those WHO OWE-- the folks who couldn't travel and buy a new before car --STILL can't travel and buy a new car. They struggled to pay their bills now they struggle a little more. At risk of insensitivity, the effect at the margin is less than you think: former McDonalds spending is on groceries, etc...

Meanwhile, the $6 and a half trillion in ready cash keeps piling up...for people with a propensity and availability to spend chunks of it. And as long as the present declining savings RATE doesn't drop in real terms...THAT PILE keeps growing. This talk about running out of pandemic cash misses the point--cash flows from a full employment, 8 million open jobs, economy have replaced every penny AND considerably more in the aggregate checking/money market pile. I believe it's the highest this cycle.

As the borrowers struggle even more. The Fed did its job marvelously well. But its time.

" This talk about running out of pandemic cash misses the point--cash flows from a full employment, 8 million open jobs, economy have replaced every penny AND considerably more in the aggregate checking/money market pile. I believe it's the highest this cycle."

oh my, us rich folks are doing just fine. Off to pickle ball , it will be 100 degrees by 10 Am PAC time, perhaps I can buy down the temp on my court ?

"I think it's more about asymmetrical risk. Deflation is more dangerous than inflation."

This is exactly right. Excess inflation is destabilizing and hard on an economy, but deflation (even mild) can be very hazardous and really hard to eliminate.

The reason deflation is so hard to eliminate is that it trains people (or businesses) to delay purchases for as long as possible. If you are considering buying a new truck, if your delay the purchase a year, you can get the truck cheaper. It becomes a death spiral. Consumers delay purchases, so businesses cut back on production and lay people off, this causes consumers to buy even less (they need to save because they might lose their jobs). It feeds on itself.

Also, imagine what regular deflation means for an economy?

It means that every year, your boss calls you into the office and gives you a small pay DECREASE. Wages go down. Even though the relative spending power of your lower wages might stay the same (i.e. your lower wages buy the same number of Big Macs because the costs of Big Macs drop as well). That is not good for moral for workers to get pay cuts every year.

It also makes businesses less likely to hire because any hiring mistakes are magnified by deflation. In an inflationary environment, mistakes made can be grown out of. In a deflationary environment, mistakes are more costly.

Furthermore deflation hurts almost everyone. It is not good for investments, it is not good for the government, it is not good for workers.

The only people who really do well in a persistently disinflationary environment are those who put their money under that mattress or in coffee cans. Encouraging people to buy cash under the matress is not good for an economy.

One of the best resources I have found when it comes to discussions on inflation, the Fed, and the economy in general is a website called https://wolfstreet.com/

The author is fairly prolific usually posting at least one article a day. Occasionally there will be two or three articles a day. Furthermore, the comment section of his articles are very active (including the author). His articles are very well sourced (usually from the Fed or other such reliable datasets). The author is very knowledgeable and very data driven. In the year or so that I have been reading the site, I have learned a lot about the ins and out of inflation (such as what is driving inflation). It is a masterclass in understanding the Fed and inflation. I cannot recommend it enough.

That said, it is not a good information source for stock investing. it is more for fixed income securities. Don't get me wrong, the author is a very smart person and he picks up stock stuff fairly quickly, but it isn't his primary cup of tea. The comment section has more than its share of cranks, goldbugs, and nuts, but there are also many other knowledgeable commentors. The author usually does a good job refuting the nuttiness.

It means that every year, your boss calls you into the office and gives you a small pay DECREASE. Wages go down. Even though the relative spending power of your lower wages might stay the same (i.e. your lower wages buy the same number of Big Macs because the costs of Big Macs drop as well). That is not good for moral for workers to get pay cuts every year.

Though this conversation can happen, wage stickiness is a problem. Most people (or their employment contracts) won't allow a pay cut, so it turns into a mix of falling company profitability and/or layoffs. This in turn leads to these same things you note: less hiring, lower aggregate demand, and so on down the drain. It's economically rational to prefer a pay cut to getting sacked, but things don't usually work out that way.

Random blathering:

Wage stickiness is one of the reasons for having an inflation target of (say) 2% instead of zero. At any given time some companies and industries are fading, and it makes sense for their workers' compensation to fall gently. People don't like nominal pay cuts, but just a bit of inflation greases the wheels to achieve what's needed. The real pay is truly getting cut slowly, but in a way that does not cause rioting. At some point the employees move on to greener pastures, with or without the failure of the firm, and on average that will be into growing industries.

The words "on average" have a lot of work to do. Some people get the muddy end of the stick, being unable to get positions in those growing areas, but there is no cure for that yet. Overall, it's better for the world for unprofitable business units to wind down and shed workers. Ask Horatio Hathaway.

Jim

The reason deflation is so hard to eliminate is that it trains people (or businesses) to delay purchases for as long as possible. If you are considering buying a new truck, if your delay the purchase a year, you can get the truck cheaper. It becomes a death spiral. Consumers delay purchases, so businesses cut back on production and lay people off, this causes consumers to buy even less (they need to save because they might lose their jobs). It feeds on itself.

I've read this before as well but never found it super compelling. People and businesses have to spend money to live/function. They can't delay every purchase indefinitely waiting for lower prices. True, I could see moving away from an inflationary economy resulting in a step function where some level of production is cut back to reach a "new norm", but I struggle to see how it would lead to an unavoidable spiral. On the positive side, I could see it resulting in less impulsive spending and debt accumulation, since inflation incentivizes both today. And a bit less of that could be a pretty good thing given that both individuals and the government are as a whole deeply in debt today.

Also, imagine what regular deflation means for an economy? It means that every year, your boss calls you into the office and gives you a small pay DECREASE. Wages go down. Even though the relative spending power of your lower wages might stay the same (i.e. your lower wages buy the same number of Big Macs because the costs of Big Macs drop as well). That is not good for moral for workers to get pay cuts every year.

I don't understand why companies would be required to pay their employees less each year in normal economic times. Wouldn't the main driver of deflation be productivity improvements allowing more goods to be produced for less, resulting in lower per unit prices? If a company is improving their productivity, they can increase their profits without cutting worker pay in normal economic times. In such an environment, it's not costing companies more to keep worker pay static in a low deflation environment, is it? (I understand recessions are a different story and the negative impacts of wage stickiness at those times). It seems like small yearly deflation could actually be a boon to workers, as static pay in an environment of small yearly price declines at a national level would result in an increase in purchasing power each year, even if an individual company's profits did not flow down to its workers.

Admittedly there's a lot of conjecture above, which is why I'd love to find a case study of a country actually trying this. One could argue that the fact it has rarely/if ever been done is enough testament in and of itself, but I'd still like to understand the rationale better.

An interesting aside - productivity increases on a nationwide level have been remarkably stable over time, averaging around 2%/yr since 1950 per https://fred.stlouisfed.org/series/OPHNFB

The reason deflation is so hard to eliminate is that it trains people (or businesses) to delay purchases for as long as possible. If you are considering buying a new truck, if your delay the purchase a year, you can get the truck cheaper. It becomes a death spiral. Consumers delay purchases, so businesses cut back on production and lay people off, this causes consumers to buy even less (they need to save because they might lose their jobs). It feeds on itself.

I've read this before as well but never found it super compelling...

Bear in mind that folks in deflationary economies don't just delay purchases, they also defer all deployments of their capital including investments. Why invest or take any risks at all if the cash in your mattress is going to be worth more a year from now anyway? And this is as true of companies as it is of individuals. With no risk taking or capital expenditures, things get pretty slow.

I don't understand why companies would be required to pay their employees less each year in normal economic times. Wouldn't the main driver of deflation be productivity improvements allowing more goods to be produced for less, resulting in lower per unit prices?

Usually this is not anything like normal economic times. In times of deflation, things are pretty broken. The usual proximate cause is a deficiency of demand. Goods stacking up, all companies have more employees than needed. So yes, you see lower per unit prices, but it's because of companies' desperation to sell something, not because of productivity gains. It tends to be long and slow and drawn out, not a crisis, but like any chronic illness it can be as serious as a sudden crisis illness.

Jim

Why invest or take any risks at all if the cash in your mattress is going to be worth more a year from now anyway? And this is as true of companies as it is of individuals. With no risk taking or capital expenditures, things get pretty slow.

Isn't this true today though? We have relatively risk-free options today such as savings accounts. Returns from those risk-free options are positive, yet massive money still flows into riskier assets like stocks in the hunt for higher returns.

Wouldn't the same return-seeking behavior be in play in the hypothetical economy under discussion, one where productivity-driven deflation was allowed by the Fed during normal economic times? A person could stuff money under a mattress for a 2%/yr return via purchasing power increase, but when other similarly risk-free options like savings accounts are available with higher real returns, why would they? Especially with the risk of house fires and theft :)

Plus, if significant mattress stuffing or the like did occur, wouldn't a reduction in money available to loan lead to higher market-driven interest rates, luring people to pull more money out of mattresses? (an equilibrium effect?)

What am I missing?

Why invest or take any risks at all if the cash in your mattress is going to be worth more a year from now anyway? And this is as true of companies as it is of individuals. With no risk taking or capital expenditures, things get pretty slow.
...
Isn't this true today though? We have relatively risk-free options today such as savings accounts. Returns from those risk-free options are positive, yet massive money still flows into riskier assets like stocks in the hunt for higher returns.
...

What am I missing?

Real short term policy interest rates are positive at the moment, which is fairly unusual. This is one reason I am collecting interest rather than buying stock...the exact unwillingness to take risks or allocate capital to productive endeavours that I mentioned. Not coincidentally, it's the exact reaction that the monetary authorities WANT to happen to cool an overheating economy because too many people are taking capital risk. Taking risks with your capital is a good thing for the economy, but you don't want it to step over the line into irrational exuberance. In any case the current situation won't last.

The current situation of positive real short rates isn't like deflation. You can get positive real rates in two different ways: we have positive inflation and higher rates (OK), not zero rates and deflation (bad). The second scenario is the one to avoid.


Plus, if significant mattress stuffing or the like did occur, wouldn't a reduction in money available to loan lead to higher market-driven interest rates, luring people to pull more money out of mattresses? (an equilibrium effect?)

I'm not sure, in general. But in particular I'm not sure that mattress stuffing would lead to scarce capital and higher rates on offer. First, a deflationary environment involves cash hoarding: usually it's in cash deposits, not physical cash in mattresses, so the financial system is stuffed to the gills with deposits they can't use because nobody wants to borrow and do stuff with the money. Second, even if they wanted to and thought they needed to, banks and other lenders would not be able to afford to offer high real rates, as they economy is in the pits and everybody's hurting, including them.

Jim

Thought filled post Knighted. After reading and rereading what came to mind - and then what could likely happen?
A potential scenario…
…increasing interest rates materialize with advent of mattress stuffing which would translate to higher rates being paid at banks on savings accounts.
And then potentially….
Mattress stuffers would then be incentivized to pull mattress money out and deposit in banks.
And then potentially….
The mattress trend reserves.

And then potentially, the Fed panics with downturn prospects and begins loosing rates and money supply grip.

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