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Does a stable price level mean an economy is at equilibrium?

phattonez

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Simple question. What do you think?
 

phattonez

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Ok, so you might be wondering what the point of this thread is.

Friedrich A. Hayek said:
Increases in the volume of circulation, which in an expanding economy serve to prevent a drop in the price level, present a typical instance of a change in the monetary factor calculated to cause a discrepancy between the money and natural rate of interest without affecting the price level. These changes are consequently neglected, as a rule, in dealing with phenomena of disproportionality; but they are bound to lead to a distribution of productive resources between capital goods and consumption goods that differs from the equilibrium distribution, just as those changes in the monetary factor that do manifest themselves in changes in the price level. This case is particularly important, because under contemporary currency systems, the automatic adjustment of the value of money in the form of a flow of precious metals will regularly make available new supplies of purchasing power that will depress the money rate of interest below its natural level.

Since a stable price level has been regarded as normal hitherto, far too little investigation has been made into the effects of these changes in the volume of money, which necessarily cause a development different from that which would be expected on the basis of static theory and which lead to the establishment of a structure of production incapable of perpetuating itself once the change in the monetary factor has ceased to operate. Economists have overlooked the fact that the changes in the volume of money, which, in an expanding economy, are necessary to maintain price stability, lead to a new state of affairs foreign to static analysis, so that the development that occurs under a stable price level cannot be regarded as consonant with static laws. Thus the disturbances described as resulting from changes in the value of money form only a small part of the much wider category of deviations from the static course of events brought about by changes in the volume of money — which may often exist without changes in the value of money, while they may also fail to accompany changes in value of money when the latter occur.

. . .

But even the essential point in the criticism of Lowe and Burchardt — the assertion that all monetary theories explain the transition from boom to depression not in terms of monetary causes but in terms of other causes super-added to the monetary explanation — rests exclusively on the idea that only general price changes can be recognized as monetary effects. But general price changes are no essential feature of a monetary theory of the trade cycle; they are not only unessential, but they would be completely irrelevant if only they were completely "general" — that is, if they affected all prices at the same time and in the same proportion. The point of real interest to trade cycle theory is the existence of certain deviations in individual price relations occurring because changes in the volume of money appear at certain individual points; deviations, that is, away from the position that is necessary to maintain the whole system in equilibrium. Every disturbance of the equilibrium of prices leads necessarily to shifts in the structure of production, which must therefore be regarded as consequences of monetary change, never as additional separate assumptions. The nature of the changes in the composition of the existing stock of goods, which are effected through such monetary changes, depends of course on the point at which the money is injected into the economic system.

There is no doubt that the emphasis placed on this phenomenon marks the most important advance made by monetary science beyond the elementary truths of the quantity theory. Monetary theory no longer rests content with determining the final reaction of a given monetary cause on the purchasing power of money, but attempts instead to trace the successive alterations in particular prices, which eventually bring about a change in the whole price system.[68] The assumption of a "time lag" between the successive changes in various prices has not been spun out of thin air solely for the purposes of trade cycle theory; it is a correction, based on systematic reasoning, of the mistaken conceptions of older monetary theories.[69] Of course, the expression "time lag," borrowed from Anglo-American writers and denoting a temporary lagging behind of the changes in the price of some goods relatively to the changes in the price of other goods, is a very unsuitable expression when the shifts in relative prices are due to changes in demand that are themselves conditioned by monetary changes. For such shifts are bound to continue so long as the change in demand persists. They disappear only with the disappearance of the disturbing monetary factor. They cease when money ceases to increase or diminish further — not, however, when the increase or diminution has itself been wiped out. But, whatever expression we may use to denote these changes in relative prices and the changes in the structure of production conditioned by them, there can be no doubt that they are, in turn, conditioned by monetary causes, which alone make them possible.

The only plausible objection to this argument would be that the shifts in price relationships occurring at any point in the economic system could not possibly cause those typical, regularly recurring, shifts in the structure of production that we observe in cyclical fluctuations. In opposition to this view, as we shall show in more detail later, it can be urged that those changes that are constantly taking place in our money and credit organization cause a certain price — the rate of interest — to deviate from the equilibrium position, and that deviations of this kind necessarily lead to such changes in the relative position of the various branches of production as are bound later to precipitate the crisis.[70] There is one important point, however, that must be emphasized against the above-named critics: namely, that it is not only when the crisis is directly occasioned by a new monetary factor, separate from that which originally brought about the boom, that it is to be regarded as conditioned by monetary causes. Once the monetary causes have brought about that development in the whole economic system which is known as a boom, sufficient forces have already been set in motion to ensure that, sooner or later, when the monetary influence has ceased to operate, a crisis must occur. The "cause" of the crisis is, then, the disequilibrium of the whole economy occasioned by monetary changes and maintained through a longer period, possibly, by a succession of further monetary changes — a disequilibrium the origin of which can only be explained by monetary disturbances.

From Monetary Theory and the Trade Cycle

*The bold was originally italicized in his work.

The point is that an economy can be thrown into a disequilibrium when new money is introduced even when you have a stable price level. This is because those closest to the inflation use the value to expand, but demand changes when that inflation is realized. Once the demand changes, you have a bust, and there is no way to avoid this, even if you have a stable price level.
 

Moot

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Re: Does a stable price level mean an economy is at equilibrium?

I think a "stable price level" means inflation is at equiliberium, which would suggest the economy (unemployment, growth rate, exchange rates) is also at an equilibrium. Currently, the Feds are using a theory called "inflation targeting" where it publically sets a target range for inflation and then adjusts interest rates to meet that target with the idea being that it helps make the Federal Reserve more transparent and predictable, which in turn gives investors more confidence. Although strict adherence to the theory is still under debate within the Federal Reserve, there is empirical evidence that shows "inflation targeting" does seem to work in creating a more stable economy.

Inflation targeting - Wikipedia, the free encyclopedia
 

oldreliable67

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Currently, the Feds are using a theory called "inflation targeting" where it publically sets a target range for inflation and then adjusts interest rates to meet that target with the idea being that it helps make the Federal Reserve more transparent and predictable, which in turn gives investors more confidence.

No. The Fed is not currently targeting an explicit inflation rate. Some commentators have suggested that the minutes of the FOMC have suggested a 'preferred inflation range' in terms of the personal consumption expenditures price index, but there is - at present, and much to the chagrin of some Fed critics - no preferred explicit inflation range, much less an explicit inflation target. The minutes do, however, describe the Fed forecasts for inflation, typically in terms of the aforemention PCE price index. Some commentators have erroneously inferred these forecasts to be targets. Not so.

It may be that the Fed will accede to the critics and begin promulgating a specific inflation target. Those critical of the Fed not doing so chiefly make the argument that a targeted inflation rate would further the Fed's efforts at transparency and accountability. After all, they say, inflation is one of the Fed's dual mandates. Supporters of the current policy reply that the Fed simply does not have the power to influence inflation rates to the same degree that it does interest rates. Both arguments have merit.
 

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No. The Fed is not currently targeting an explicit inflation rate. Some commentators have suggested that the minutes of the FOMC have suggested a 'preferred inflation range' in terms of the personal consumption expenditures price index, but there is - at present, and much to the chagrin of some Fed critics - no preferred explicit inflation range, much less an explicit inflation target. The minutes do, however, describe the Fed forecasts for inflation, typically in terms of the aforemention PCE price index. Some commentators have erroneously inferred these forecasts to be targets. Not so.

No, perhaps not explicitly. But in a speech where Bernake once described how Germany's Bundesbank indirectly targeted inflation, it seems to parallel the way the Feds use the Federal Fund rate....

"...For example, the Bundesbank, though it conducted short-term policy with reference to targets for money supply growth, derived those targets each year by calculating the rate of money growth estimated to be consistent with the bank's long-run desired rate of inflation, normally 2 percent per year. Hence, the Bundesbank indirectly targeted inflation, using money growth as a quantitative indicator to aid in the calibration of its policy. Notably, the evidence suggests that, when conflicts arose between its money growth targets and inflation targets, the Bundesbank generally chose to give greater weight to its inflation targets (Bernanke and Mihov, 1997).1 FRB: Press Release--FOMC statement --August 10, 2010
And isn't using money growth as a quantitative indicator what the Feds are doing when set a target range for the Federal fund rate?

Bernake goes on to describe "constrained discretion" as part of the communication strategy framework for inflation targeting....

"...Nevertheless, for expository purposes, I find it useful to break down the inflation targeting approach into two components: (1) a particular framework for making policy choices, and (2) a strategy for communicating the context and rationale of these policy choices to the broader public. Let's call these two components of inflation targeting the policy framework and the communications strategy, for short.

Under constrained discretion, the central bank is free to do its best to stabilize output and employment in the face of short-run disturbances, with the appropriate caution born of our imperfect knowledge of the economy and of the effects of policy (this is the "discretion" part of constrained discretion). However, a crucial proviso is that, in conducting stabilization policy, the central bank must also maintain a strong commitment to keeping inflation--and, hence, public expectations of inflation--firmly under control (the "constrained" part of constrained discretion). Because monetary policy influences inflation with a lag, keeping inflation under control may require the central bank to anticipate future movements in inflation and move preemptively. Hence constrained discretion is an inherently forward-looking policy approach....."
FRB Speech, Bernanke--A perspective on inflation targeting--March 25, 2003
Apparently, one of the Feds worse fear is losing the publics expectation in it's ability to control inflation.

And then consider the "constrained discretion" of the FOMC's recent August 10th statement when they said they will keep the target range for federal fund rate exceptionally low for an "extended period" in anticipation of stable inflation expectations.

"....The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period......
FRB: Press Release--FOMC statement --August 10, 2010

Constrained language like "extended period" suggests inflation targeting, imo.

It may be that the Fed will accede to the critics and begin promulgating a specific inflation target. Those critical of the Fed not doing so chiefly make the argument that a targeted inflation rate would further the Fed's efforts at transparency and accountability. After all, they say, inflation is one of the Fed's dual mandates. Supporters of the current policy reply that the Fed simply does not have the power to influence inflation rates to the same degree that it does interest rates. Both arguments have merit.
I think the Feds recent statement of caution and keeping the target range for Federal fund rate exceptionally low for an "extended period" suggests they are using a "soft" form of inflation targeting but are communicating it in a quantitive manner so as to allow themselves the freedom and flexibility neccessary to make adjustments in such a highly politicized and unpredictable climate.

It was interesting to note the comparison Bernake made in his speech, that due to the nature of the American public and the reaction they have to anything new and/or don't understand, that to introduce the idea of "inflation targeting" would likely have the same effect that introducing the metric system did.
 
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oldreliable67

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A thoughtful and well-presented post. Good job with that.

The Feds current approach does indeed fit well with BB's concept of 'constrained discretion.' Nonetheless, as I said and to which you have agreed, the Fed does not currently explicitly target an inflation rate. However, as I noted, the Fed does incorporate their forecasts for inflation, which are generally couched in terms of their expected rate of change in the price index for PCE, into policy considerations.

The public's inflation expectations also may influence policy decisions, as evidenced by the frequent mention of such in the FOMC minutes and public discourse by the governors and presidents. The measure of public inflation expectations most often mentioned is the spread between TIPS and straight treasuries. Though perhaps mentioned less often, the inflation expectations component of consumer surveys (Conference Board and U of Mich) are also considered.

Consequently, it can fairly be said that inflation expectations derived from their internal forecasts as well as investors/consumers may influence but do not dictate policy decisions.

Increasing policy transparency has been an ongoing objective at the Fed for some time now. In prior years, especially in the late '70's thru the mid- to late- '80's, daily Fed intervention time became a guessing game as to Fed intentions: When was a repo for a customer account really an indication of a change in policy and when was it really just a repo for a customer account? Indeed, a sizable cottage industry built up around divining Fed intentions based on their actions from about 11:30 a.m. till about 12:15 every day. Several costly mistakes in interpretations of policy changes/non-policy changes were a strong impetus for the move toward more transparency.

As the need for more transparency become increasingly evident, the Fed began to telegraph it's intentions thru comments to well-place financial journalists. Never for attribution except occassionally to that (in)famous "un-named Fed official," the market soon learned to give a rather high probability that John Berry (thought by some to have been used by Greenspan to transmit information to the market) and a couple of others had been selected for the task of assisting the market in it's interpretation of recent or sooon-forthcoming Fed actions. As the Fed's efforts at increased transparency became more developed and more polished, such 'leaks' became unnecessary.
 

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Only with the assumption of perfect information and completely equal input factors/costs.
 

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Couldn't all this be more easily explained by the Keynsian Cross.

It's not the same thing at all. This is merely asserting that an economy will have to adjust if you introduce inflation. Everything will have to adjust to the new prices (although a stable price level may remain, you can be sure that individual prices will fluctuate). This is always the case if you change the monetary base. It's why I'm asserting that any kind of monetary inflation will necessarily lead to a crash. However, of course, the more you introduce, the bigger the crash.
 

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Seems like you prefer to ignore the point of this thread. The Taylor Rule cannot avoid causing the economy to leave equilibrium.

The economy is always in "equalibrium". In our current equilibrium, we are not maximizing output.
 

phattonez

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The economy is always in "equalibrium". In our current equilibrium, we are not maximizing output.

You change relative prices when you introduce inflation and all prices have to adjust due to uneven insertion of that money into the economy. Did you even read the first post?
 

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You change relative prices when you introduce inflation and all prices have to adjust due to uneven insertion of that money into the economy. Did you even read the first post?


:golf I'll wait for you to make a point.
 

phattonez

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:golf I'll wait for you to make a point.

I made it, you just want to ignore it. Introducing inflation benefits certain groups at the ultimate expense of other groups. It distorts production and necessitates a correction.
 

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I made it, you just want to ignore it. Introducing inflation benefits certain groups at the ultimate expense of other groups. It distorts production and necessitates a correction.

Inflation is a naturally occurring phenomena. Even during the mercantilist golden era (pun intended), inflation was the end result of a growing economy. Anyways....

Care to identify the groups who are getting the shaft along with a rough estimate of these particular demographic's disposable incomes?
 

phattonez

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Inflation is a naturally occurring phenomena. Even during the mercantilist golden era (pun intended), inflation was the end result of a growing economy. Anyways....

You're talking about a rising price level. I'm talking about adding new bills into circulation.

Care to identify the groups who are getting the shaft along with a rough estimate of these particular demographic's disposable incomes?

The people who get the loans get the benefit and everyone else gets the shaft because the value of the money that they have must fall.
 

Moot

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A thoughtful and well-presented post. Good job with that.
Thank you, it was a rare moment. LOL

...snip.....Increasing policy transparency has been an ongoing objective at the Fed for some time now. In prior years, especially in the late '70's thru the mid- to late- '80's, daily Fed intervention time became a guessing game as to Fed intentions: When was a repo for a customer account really an indication of a change in policy and when was it really just a repo for a customer account? Indeed, a sizable cottage industry built up around divining Fed intentions based on their actions from about 11:30 a.m. till about 12:15 every day. Several costly mistakes in interpretations of policy changes/non-policy changes were a strong impetus for the move toward more transparency.

As the need for more transparency become increasingly evident, the Fed began to telegraph it's intentions thru comments to well-place financial journalists. Never for attribution except occassionally to that (in)famous "un-named Fed official," the market soon learned to give a rather high probability that John Berry (thought by some to have been used by Greenspan to transmit information to the market) and a couple of others had been selected for the task of assisting the market in it's interpretation of recent or sooon-forthcoming Fed actions. As the Fed's efforts at increased transparency became more developed and more polished, such 'leaks' became unnecessary.

Well, I you think you have a lot more to remember than I do. I'm just a novice at this economy business but the more I learn, the more interesting it seems to get, so feel free to correct me. So yes, transparency has been ongoing issue inside the Fed for quite awhile, but it's only been since 1999 that they have provided statements after every FOMC meeting. Sorry to keep referring to Ben Bernake but he does talk about that very subject in detail and it is quite interesting because he says the Feds realized that by providing some communication to the market that it gave them a very powerful tool, that they can use to create "expectations" and lead the market participants in the direction they want.....

These potential benefits have not been lost on Federal Reserve policymakers. Certainly, the development of the FOMC's post-meeting statement over the past decade suggests an increasing awareness of the practical advantages of increased transparency and communication. As hard as it may be to imagine, given the prominence afforded to FOMC statements today, before 1994 the FOMC issued no post-meeting statement, not even an announcement of its decision about the federal funds rate. Instead, in most instances, the Committee signaled its decision to financial markets only indirectly through the open-market operations used to affect the rate.2 In February 1994, the FOMC began to release statements to note changes in its target for the federal funds rate but continued to remain silent after meetings with no policy changes. Statements have been released after every meeting only since May 1999.....snip

Our findings support the view that FOMC statements have proven a powerful tool for affecting market expectations about the future course of the federal funds rate.6 ...snip

We also confirmed that FOMC statements tend to move market beliefs in the direction one would have expected....snip

As I observed earlier, much of the potency of monetary policy lies not in the FOMC's ability to affect today's federal funds rate but rather in the Committee's ability to influence market expectations about future policy and, consequently, the economically more relevant long-term rates. On this important metric, the statement has become an increasingly important tool of policy. Of course, as I have already emphasized, talk is of no value if market participants do not believe that the FOMC intends to follow through on its plans--adjusting as necessary, of course, to developments in the economy. In the long run, talk and action must complement and reinforce each other if policy is to be effective.....snip
FRB: Speech, Bernanke—Central Bank Talk and Monetary Policy—October 7, 2004

After reading it again, I thought the below paragraph was very interesting as it seems to pertain to the economic condition we are in now....
The Bank of Japan's recent policies illustrate the centrality of communication policies. In April 1999, the Bank of Japan (BOJ) not only reduced its call rate to within a few basis points of zero, it also announced its attention to keep the call rate at zero "until deflationary concerns are dispelled." This policy, known as the zero-interest-rate policy, or ZIRP, was interrupted by a 25-basis point rise in the call rate in August 2000 but then effectively re-introduced in March 2001 in conjunction with the BOJ's new policy of quantitative easing.10 The BOJ's goal in committing to the ZIRP was to persuade participants in the Japanese bond market that short-term rates would remain low for longer than they had thought--a commitment that, if credible, should result in longer-term rates being lower than they otherwise would be.

Did the ZIRP influence longer-term rates as intended? I will spare you the details but report that our tentative answer is "yes." .....snip

FRB: Speech, Bernanke—Central Bank Talk and Monetary Policy—October 7, 2004
So from what I gather from BBs comments on BoJ above, and since we are at ZIRP now and the Feds just did quantitive easing on T-bills and since last weeks FOMC's statement said they would keep Fed fund rates low for an "extended period" then that should give investors the expectation that long term interest rates will remain low for about another year as well. Does that sound about right to you?
 
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Moot

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Seems like you prefer to ignore the point of this thread. The Taylor Rule cannot avoid causing the economy to leave equilibrium.
I could be wrong but the Taylor Rule sounds very much like inflation targeting. And it is my understanding that the whole idea of inflation targeting is to control inflation and keep it stable so the economy is at an equiliberium. Of course external forces like a sharp increase in ME oil prices could inflate prices and upset the equilibrium, but in the US the impact would be minimal because our economy is so large and adjustments could be made to keep oil prices from effecting the overall economy. And too, we try to spread the risk by not getting all our oil from one source.

Are you familiar with fractional reserve banking? I only ask because it seems to me that it is borrowing and interest on borrowing that artifically expands the money supply more than the actual printing of money. And too, most people deposit their paychecks into banks and use personal checks and credit cards and borrow more than they save rather than keep loads of green cash in their wallet. I guess what I'm trying to say is the Feds probably control the money supply when they lend out from their own reserves to secondary banks who then lend to commerical banks who then lend to business and consumers. Each time the same dollar is lent down the line it has the effect of expanding the money supply. But if the borrowed money isn't getting invested in anything that creates value such as factories or businesses, and the banks can just lend to each other and still make billions off the interest like they are now, then voila, money supply from thin air and the money has less value, because it isn't creating value from tangible goods and investments.
 
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oldreliable67

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Moot said:
So from what I gather from BBs comments on BoJ above, and since we are at ZIRP now and the Feds just did quantitive easing on T-bills and since last weeks FOMC's statement said they would keep Fed fund rates low for an "extended period" then that should give investors the expectation that long term interest rates will remain low for about another year as well. Does that sound about right to you?

Essentially, yes, but with a couple of minor corrections:

The quantitative easing had nothing to do T-bills per se. Rather, it had to do with the reinvestment of the proceeds of interest income and maturing securities from the Fed's now rather large portfolio into additional U.S. government securities. Though the proceeds could be reinvested in T-bills (non-interest bearing securities with less than one year to maturity and issued at a discount from face value, then ultimately redeemed at face value), the proceeds would typically be invested in longer-dated coupon-bearing securities. Indeed, the Fed announced that their preferred maturities would be in the 2 year to 10 year range.

And yes, one would expect first, the continuation of the ZIRP for as far as the eye can see, and secondly, this additional demand for treasuries in the 2 year to 10 year maturity range to help keep all interest rates lower than might have otherwise obtained.

Moreover, as the Fed tries to manage expectations, they are no doubt aware that this recent small re-introduction of quantitative easing has strengthened expectations that should the economy continue to soften, the Fed will first rely on an expansion of quantitative easing far greater than this recent rather small step. Market participants just now are wondering where the next stop will be with respect to the size of the Fed balance sheet: it is now about 2 trillion, will the next stop be at 3 trillion? If so what consequences does that suggest for the inflation/deflation outlook?

Stay tuned!
 
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oldreliable67

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Moot said:
I only ask because it seems to me that it is borrowing and interest on borrowing that artifically expands the money supply more than the actual printing of money.

Almost. Borrowing and lending, not borrowing and interest on borrowing.

Moot said:
...the Feds probably control the money supply when they lend out from their own reserves to secondary banks who then lend to commerical banks who then lend to business and consumers. Each time the same dollar is lent down the line it has the effect of expanding the money supply. But if the borrowed money isn't getting invested in anything that creates value such as factories or businesses, and the banks can just lend to each other and still make billions off the interest like they are now, then voila, money supply from thin air and the money has less value, because it isn't creating value from tangible goods and investments.

Again, almost. There really isn't a tier of "secondary" banks in the sense that I get from your description. The function or role played by your secondary banks is fulfilled by the regional Fed banks themselves. These banks act as the regional depositories for banks that are members of the Federal Reserve system in the respective regions. You might say that the Fed regional banks are the "secondary" banks in your description.

The spirit or intent of the balance of your post is quite right but requires a bit of elaboration and a small correction. The banks are in general not "just lending to each other and making billions." If that were the case in the literal sense you suggest, bank lending would be a zero sum game: every banks interest income would be another banks interest expense.

A bank typically borrows from another bank in the "Fed Funds" market, that is, a bank that needs reserves borrows another banks unused and otherwise idle reserves. Reserves are typically borrowed to assist in meeting loan demand, especially in an expanding economy. It is also done to fund an increase in the investment portfolio.

Indeed, at this point in the business cycle, with a sharply positively sloped yield curve (yes, flatter of late, but still quite positive), banks typically will rebuild capital lost in loans gone bad through profits derived from borrowing short (Fed funds at effectively zero) and lending long at a significantly higher rate. (Treasuries are currently plus anywhere from about 50 to over 350 basis points over Fed funds depending on the maturity.)

Overall loan demand continues relatively weak, and to paraphrase your description, "the borrowed money [what little there is of it] isn't getting invested in anything that creates value such as factories or businesses," it is being invested in treasury securities in the borrow short/buy long strategy very typical of this point in a business cycle.
 

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I could be wrong but the Taylor Rule sounds very much like inflation targeting. And it is my understanding that the whole idea of inflation targeting is to control inflation and keep it stable so the economy is at an equiliberium.

Did you read my first post? With any kind of monetary manipulation you induce an economy to go out of equilibrium. There is no way around that. Read my quotes in the first posts.
 

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phattonez said:
It's why I'm asserting that any kind of monetary inflation will necessarily lead to a crash. However, of course, the more you introduce, the bigger the crash.

So you don't believe that a little inflation, say 1% - 2% is desirable?

Actually, isn't the economy always in equilibrium? Isn't what you're really referring something that destabilizes and moves the system from an existing equilibrium to a new equilibrium? Among the myriad of assumptions required in economic theory/models, isn't it usually assumed that the system is always in equilibrium until something either exogenous or endogenous destabilizes and instantaneously moves the system to a new equilibrium?

I always liked that 'instantaneous' assumption.
 

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It's not the same thing at all. This is merely asserting that an economy will have to adjust if you introduce inflation. Everything will have to adjust to the new prices (although a stable price level may remain, you can be sure that individual prices will fluctuate). This is always the case if you change the monetary base. It's why I'm asserting that any kind of monetary inflation will necessarily lead to a crash. However, of course, the more you introduce, the bigger the crash.

Not sure why it would necessarily lead to a crash. The economy will eventually adjust as you say, and the inflation will have no effect on relative prices in the long run (Fisher Effect).
 

phattonez

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So you don't believe that a little inflation, say 1% - 2% is desirable?

A rising price level in general? I don't really care about the price level because it's not a worthwhile measure (except in extreme cases).

Actually, isn't the economy always in equilibrium? Isn't what you're really referring something that destabilizes and moves the system from an existing equilibrium to a new equilibrium? Among the myriad of assumptions required in economic theory/models, isn't it usually assumed that the system is always in equilibrium until something either exogenous or endogenous destabilizes and instantaneously moves the system to a new equilibrium?

I always liked that 'instantaneous' assumption.

The change is never instantaneous. When inflation is introduced and that money is given to certain companies, prices have to change relative to each other in order for equilibrium to be reached. Until that happens you're living in an economy that has not adjusted yet.
 
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