Monday, May 07, 2012

Fed policy benefits wealthy

From Tim Duy:

Bernanke's Shift

"There has been a fierce counterattack to Federal Reserve Chairman Ben Bernanke's assertion that he is indeed the same Professor Bernanke that advised the Bank of Japan a decade ago. DeLong identifies this 1999 Bernanke quote:
[Si]nce 1991 inflation has exceeded 1% only twice... the slow or even negative rate of price increase points strongly to a diagnosis of aggregate demand deficiency…. [C]ountries that currently target inflation… have tended to set their goals for inflation in the 2-3% range, with the floor of the range as important a constraint as the ceiling….
and concludes that Bernanke previously believed the inflation target should be between 2 and 3 percent, with 2 percent being a floor.  One could infer, then, that Bernake at one point believed in a symmetric objective around 2.5 percent, with a hard floor and ceiling on 50bp of either side of that objective.  Now the Fed has sanctified a 2 percent target.

I think we can conclude, by Bernanke's statement's in the past and the actual path of inflation now, that Bernanke has embraced the recession as yet another exercise in opportunistic disinflation in which the Fed can knock another 40bp off the expected rate of inflation.

Monetary policy is not neutral with regards to the distribution of income and wealth.  The Fed does not want inflation to exceed the 2 percent inflation target as that will result in a new distribution.  The subsequent alterations to the outcomes will not be symmetric; some will gain more than 2.5 percent, some will lose more.  

Note - and I think this is important - when Bernanke's Fed took the opportunity to shift down the path of inflation by sanctifying the 2 percent target, they were comfortable with the subsequent shift in the distribution of outcomes.  And consider that shift.  At a time when households were overwhelmed with excessive debt, the Fed deliberately chose to increase the real burden of the debt by changing the inflation trajectory.

Why one would use a balance sheet recession to shift downward the path of prices is certainly something of a mystery.  But it does imply that the Fed wanted to induce a new distribution of outcomes, even knowing that the beneficiaries would not be households. The Fed must also know that the by reducing the path of inflation they have knowing altered the distribution of outcomes in a way that is likely to slow the pace of recovery.

To summarize, the Fed has shifted monetary policy to favor those who hold large amounts of financial assets; and claims it hasn't done so.


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