Explaining the Fed Credibility Argument

Following up on my last post, I actually think that there are two possible explanations for the “Fed Credibility” argument’s wide deployment, both hinted at in Simon’s response to my comment:

I think the credibility argument is really about the underlying motives of the policymakers, rather than their abilities. However I also think that argument is overdone – it takes a few generations to forget the lessons of the past, and policymakers are still obsessed with the 1970s.

In my words, two possibilites:

1. It’s a smokescreen. Actual reason: Creditors hate (unexpected) inflation. One extra percentage point transfers hundreds of billions of dollars of buying power from creditors to debtors, annually. ‘Nuf to get a fellow’s attention. The Fed is run by creditors.

2. (70s) They actually are worried — that the higher inflation target won’t work in goosing the economy or employment, so they’ll run into a stagflation situation where stomping on (spiraling?) inflation is…problematic. So they won’t be able to fulfill the second half of their promise without causing a job recession a la Volcker. Rock and a hard place.

 Cross-posted at Angry Bear.
  1. Olav Martin Kvern
    December 4th, 2012 at 19:42 | #1

    Hi Steve,

    I agree with Simon–they’re obsessed with the 1970s. Which is interesting, because I think any sane or compassionate person would prefer the economic environment of 1970s to that of today. I’d take “stagflation” over outright depression any day.

    Our pet phrase–“they never learn, and they never forget”–seems apt. Our current crop of policy makers managed to learn a tiny bit in the 1970s–in politics (still angry about Nixon), in economics (still angry about Carter and OPEC), in culture (damn hippies!), and in the bedroom (still searching for the g-Spot), etc. Reality may have changed, and what they think they learned may have been wrong, but that isn’t making a dent in their preconceived notions.

    Also, it strikes me that the Credibility Fairy is probably the sister of the Confidence Fairy.

    Thanks,

    Ole

  2. December 5th, 2012 at 08:32 | #2

    @Olav Martin Kvern

    I guess it’s a question of confidence: would a higher (wage) inflation target bring unemployment down?

    Modern monetarists are unequivocal that it would. So the fed shouldn’t worry.

    The Fed (assuming explanation #2) is less sanguine.

    Interestingly, as a liberal who tends to view conservative-dominated monetarism with a sceptical eye (what we really need is fiscal stimulus!), I have some sympathy for that (presumed) fed concern.

    “Also, it strikes me that the Credibility Fairy is probably the sister of the Confidence Fairy.”

    Indeed. But that doesn’t mean that the Credibility Fair might not have somewhat better legs.

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