federal reserve

Usually the Fed waits too long before raising interest rates. The pressure to delay is particularly strong today. One reason is the sharp decline in the trend growth rate of the US. As I have pointed out in these blogs, this is the result of a sharp fall in the growth of the population of working age and in productivity. In the decade prior to the financial crisis (1997 to 2007), the numbers in the US of those aged 15 to 64 grew at 1.38 per cent per annum and is now forecast to rise over the next decade at only 0.18 per cent per annum (chart one).

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In the past governments have funded their deficits – for example, they have borrowed in the bond market rather than through treasury bills. This is despite the fact that, for the past 80 years, the rate of interest on bonds has been greater than that on Treasury bills; that is, we have had an upward sloping yield curve.

I suggested in a recent blog that this was because governments correctly perceived that there were considerable economic risks in not funding, and that it was worth paying the additional cost to avoid these risks. Quantitative easing, which is a form of underfunding, must therefore have increased these risks. Defenders of QE need either to argue that these risks have not risen or that the benefits we have received from QE outweigh the rise in risks. To be consistent, those who hold that no additional risks have been incurred must now hold that governments should not have funded in the past and must now stop. But their silence is deafening, and such views are implausible, being held, I think, in the hope of dissuading discussion rather than from any conviction that they would survive much debate. Read more

Comments are flying around about whether inflation or deflation is the greater risk. This is almost invariably interpreted as asking which is the most likely and therefore misses the central point. Inflation is a much greater risk – not because it is more likely but because its consequences are far worse.

Deflation has been demonised. It has been harmless or even beneficial in Japan. While I think it would hurt the eurozone, its impact would be mild and easily reversed – or it would be if German economic policy was not so obstinately foolish. Inflation poses a much more serious problem, particularly in Japan, the UK and the US. Read more