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Economic View

Can the Fed Offer a Reason to Cheer?

By TYLER COWEN

Published: September 18, 2010

EXCERPT:

How can this be? Supplying more money did not actually result in enough additional spending. The debilitating financial shock of the last few years convinced many consumers and businesses that they needed to save more. So they are holding on to much of the new money.

Given this problem, there is a logical and seemingly simple move available to the Fed: just make people believe that it is seriously committed to increasing the rate of inflation. Traditionally, the Fed has focused on restraining inflation, not stoking it. But these are unusual times.

If the Fed promises to keep increasing the money supply until prices rise by, say, 3 percent a year, people should eventually start spending. Otherwise, if they just held the money, it would be worth 3 percent less each year.

In a self-fulfilling prophecy, the Fed could stimulate spending and the economy, and at no cost to the Treasury. Of course, if no one believes the Fed’s commitment to price inflation, spending and employment will not go up. The plan will fail, and people will view their skepticism as vindicated.

In other words, one of our economic problems can be solved, but only if we are willing to believe it can. Ben S. Bernanke, the Fed chairman, wrote about this conundrum before he accepted his current job. In 1999, when discussing what the Japanese central bank could do about the country’s deep recession, Mr. Bernanke suggested “a target in the 3 to 4 percent range for inflation, to be maintained for a number of years,” saying that it would show the bank’s credible commitment to reflate the economy.

Sadly, although Mr. Bernanke clearly understands the problem, the Fed hasn’t been acting with much conviction. This is understandable, because if the Fed announces a commitment to a higher inflation target but fails to establish its credibility, it will have shown impotence. It would be a long time before the Fed was trusted again, and the Fed might even lose its (partial) political independence. All of a sudden, the Fed would end up “owning” the recession.

Part of the credibility problem stems from the political environment, especially in Congress. Imagine the day after the announcement of a plan for 3 percent inflation. Older people, creditors and workers on fixed incomes — all connected to powerful lobbies — would start to complain. Republicans would wonder whether they had found a new issue on which to campaign, namely, opposition to inflation. And Democrats would worry about what position to take. Presidents of some regional Fed banks would probably oppose the policy publicly.

Although the unemployed might prefer such a policy, they are not well-mobilized politically. And President Obama is himself politically weak at the moment, so he cannot offer the Fed much cover.

Can the Fed walk down this path without blinking? Perhaps not.

Full article @ NYTimes.com

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This could work. It is a bit complicated to understand.. but essentially, it is the combination of massive expansion in money supply coupled with inflationary pressure that will spur people to spend ahead of inflation hitting (if they truly believe inflation is coming).

It will take tremendous bipartisan support to get this done.. I doubt the POTUS has any clout to accomplish this at this time.

-- Edited by Sanders on Saturday 18th of September 2010 09:22:03 PM