In this week’s podcast, Simon Lack explains why the Fed should stop buying bonds
https://sl-advisors.com/wp-content/uploads/2013/04/logo1.jpg00Simon Lackhttps://sl-advisors.com/wp-content/uploads/2013/04/logo1.jpgSimon Lack2021-05-14 09:30:272021-05-14 09:29:25Episode 73: Inflation Is Here
You want the Fed to substitute your opinion for theirs. Why is your opinion any better? Your analysis appears to be based on US inflation during the 1970s. Economically, we now live in a different world.
The bond market and bond vigilantes have an extraordinarily poor track record of predicting inflation. This has been well documented. There are many published studies of the incompetence of the bond market to accurately predict the future.
During the 1970’s there were clear inflation transmission mechanisms, particularly wage and contract provisions with COLAs (cost of living adjustments) and large wage contracts which set the pattern for wage negotiations throughout the economy. Also, the economy was near full employment. During the 1970’s, we had the worst of all possible worlds, some prices in the economy were fixed (e.g. bonds terminal value, fixed price contracts) and some were adjustable (e.g. wage and other contracts with COLAs) and the economy was near full employment. This combination wrecked havoc on the economy. During the 1970s. wage inflation provided the major inflation transmission mechanism.
Today. we are far from full employment and there are no clear inflation transmission mechanisms. Most prices are far more flexible today than the 1970s. Today, workers have almost no pricing power. Recycled analyses from the 1970’s are not going to work today.
Maybe the Fed and administration are over doing their collective response to the effects of the pandemic. No one really knows. Their bet is that it is better to overdo the nation’s response to the pandmeic and reposition the economy for the future than to underdo the response, limp along feebly for a prolonged period and perpetuate the slow growing economy that we’ve enjoyed for the last decade. Their bet is that the Fed has the tools to cool down our highly financialized economy quickly if necessary.
Inflation is not in itself evil or necessarily destructive. Inflation can have harmful economic effects in some contexts helpful in others, so can deflation and stable prices. Both inflation and stable/falling prices can cause stagnation or declining GDP in particular contexts.
There is a big difference between temporary and persistent inflation.
The trick is to get the right mix of policies that get the economy moving in the desired direction and not get hung up on one parameter, like inflation.
Even bond market is not convinced that inflationary pressure will persist