Friday, January 29, 2010

Raising Interest Rates on Reserves and a Jobs Bill at the same time?

Prompted by a column by Allan Meltzer:
Firstly, Mr. Meltzer's opinion on the Phillips curve is very interesting. He claims that the Phillips curve doesn't work, citing history. Paying high interest rates on reserves worsens inflation because you're actually adding more capital to the economy, just later.
I'd like to see a better argument for why the Phillips curve doesn't work than simply "it didn't work in the 70s". One of the big problems in the 70s was that we were heavily oil-constrained, and so even if there was excess labor or capital capacity, one of our critical inputs limited growth so that extra money put into the economy worsened inflation. Had the money gone towards non-oil-intensive parts of the economy, I wonder if we wouldn't have avoided stagflation. Additionally, from what I understand, Volcker's willingness to have high interest rates was what ended the inflation portion, and then from that recession, he lowered rates to get the economy going again. Thus, I'm still unsure about whether Mr. Meltzer's claims are accurate.
It is ridiculous and incredibly counterproductive, by the way, to come out with an $80 billion jobs bill AND increase interest rates on reserves. Those two policies will counterbalance each other on employment, and worsen inflation by increasing government spending without stimulating any demand at all. I don't hate some parts of the jobs (read: second stimulus) bill, but I'm not such a big fan of the "raising interest rates on reserves" policy - I'd rather see the Fed sell more government securities, although maturity mismatch is an underreported issue right now.

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