Sunday, December 16, 2007

Angus's Question: I second!

Angus raises some questions.

This question seems pretty simple to me, which probably means I don't have a good handle on the problem.

But the question is not: "Can/Should the Fed try to improve the balance sheets of for-profit financial institutions through reducing key bellwether rates, and through open market operations?"

If forced to answer that question, I would "no" to the shouldn't part, because I would answer "no" the can part: The problem is solvency, not liquidity. (Yes, I know Krugman makes this argument, that's why I think I must be wrong!). The Fed can't solve that problem.

There is a useful question, though, and that is the one Angus raised. And that question is: "Should the Fed accomodate large changes in relative prices (energy, some food) by translating actual real price change into inflation through an expansive monetary policy?"

That is the question actually presented to the Fed, and to the policy community. And that's the question I would like to hear answers to. Me? I vote, "No."

Note that I am NOT saying that the Fed should allow, or foster, DEFLATION if it comes to that. But we are a very long way from deflation. I wouldn't accomodate a deflation, either.