Thursday, February 12, 2009

Monetary vs. Fiscal Policy.

As I posted a few days back, the recent increase in the TIPS spread implies that expectations of future inflation are increasing. Will over at the Ambrosini critique takes this as clear evidence that the Fed's monetary policy is finally working. Maybe he's right, but that wouldn't be the first thing that comes to my mind. I'm biased of course, b/c I am for the stimulus, while Will is not, but usually, when any government announces a large new spending package, the yields on its long-term bonds increase. That's totally standard. Remember what happened to long-term yields when Clinton passed his balanced budget? They dove. Some of the increase in the TIPS spread has just *gotta* be the stimulus.

Of course, most conservatives believe the stimulus was much too large and too heavily weighted toward spending. I think it was too small, and too heavily weighted toward tax cuts. The increase in the TIPS indicates that the probability that I'm wrong -- that the stimulus is enough -- just went up. (Although I think it's still small.)

If Will is right, and the Fed is behind the increase in the TIPS spread, then we should see a nice little pop in the January CPI when the figures are released next week. However, I'm going to go out on a limb and predict that we won't see much of an increase in the core CPI. (Of course, I'll eat my shirt if I'm wrong...) If it's flat, I think we can say that the Fed is basically fighting deflation to a standstill (an achievement). If it falls at all, then monetary policy is, for all intents and purposes, broken. Why? Well, we've had deflation in the total CPI for four months now, and basically a flat CPI, and massive increase in unemployment. By mid December, if not well before, it should have been clear as crystal to the Fed that it shouldn't leave any arrows in its quiver. Any additional non-standard policy idea the Fed has had, it should have started testing them well before January... The only other conclusion is that the Fed has been overly cautious and is thus at fault...

No comments:

Post a Comment