Greenspan: Wake up! Interest hikes FUEL inflation.

Miscellaneous and Personal Stuff I Must Share
1

They directly drive up the cost of the standard economic “shopping basket” for anything involved with interest:

  • Housing variable-rate loans
  • Rental prices for tenants of landlords with variable-rate loans.
  • Cars leased.
  • Cars bought in time payments.
  • Any object in any category bought with a charge card.
  • This now includes all basic items, even food and charitable donations.

Who are the only people helped by higher interest rates?

  • Bankers

Who is Greenspan and all of his pals?

  • Bankers

Why does all of Washington applaud this guy?

2

Ah, but these increases are increases in cost, not increases in price. And the inflation index only measures increases in price. Also, it’s only we peons who really suffer from these interest rate increases anyway – for the truly rich, the effect on the day-to-day budget is minuscule.

Actually, the effect on Joe Sixpack’s lifestyle is one of the reasons behind the interest rate increases. A tighter household budget means a less uppity worker. Also, the lower unemployment created by a gung-ho economy means a more uppity worker. Everything Greenspan does, he does to keep workers from claiming their rightful share of the national pie and perpetuate the ongoing redistribution of lucre to the super-rich. Who, when you get right down to it, are the only people really hurt by inflation. Inflation fueled by increases in workers’ salaries would be good for the country, because median income would increase faster than prices. On the flip side, when you’re living off the interest off a bunch of 8 percent zero-coupon bonds and inflation goes from 0 to 2 percent, suddenly – horrors! – you have to live off 6 percent interest instead, and that simply won’t do.

3

Greenspan kinda pisses me off. His stupid hikes in my opinion are much to blame for the current crappy stock market. Plus when this guy speaks, it’s in parables. Nothing comes across CLEAR. Everytime he makes a speech there are multiple interpretations of what he says. If inflation were a termite in a house, Alan Greenspan would blow up the house to solve the problem. He has done a few good things, but overall he is a putz if you ask me.

4

Greenspan is many things, but he’s not a putz. He knows exactly what he’s doing.

5

Funny, the economy is better than it has ever been, in no small part due to Greenspan, yet people still find something to complain about.

6

Um, are you being wilfully obtuse, or are you just too young to remember what real inflation is? Why don’t you do a little research, say on 1970s America (not even Weimar Germany) and see just how good inflation is for “Joe Sixpack.” Real wages never increase faster than inflation, so inflation always means decreasing real wages.

Inflation typically was driven by rises in the costs of goods, but our economy today is much more service-driven than ever before (not to mention the other categories of human costs), which makes the picture differently. If the high-tech sector wasn’t so important – and its overwhelming and relentless downward price spiral so pronounced – I bet we’d have seen some serious inflation already. (Some would say we have, in the stock market.)

7

langour is confused about a couple of things.

  1. Bankers do not like higher interest rates! Banks profit from the spread: the difference between borrowing and lending rates. Increases in official rates raise banks’ costs. They do not profit from this. In fact, they lose, since the volume of lending is less and because if the interest rate change is unexpected, some people default.

  2. The relationship between interest rates and inflation is trickier. You are quite right to say that higher interest rates have an impact on the basket of goods. But this is just measured inflation: the question is what happens to the underlying inflationary forces.

Higher interest rates reduce current demand by investors and consumers. To the extent that the inflation is “caused” by demand outstripping productive capacity, this eases the inflationary pressure.

picmr

8

Langour pontificates:

Um, yeah, that’s the point. Ever heard of “supply and demand”? When demand is bigger than supply, prices go up. When supply is bigger than demand, prices go down.

  1. When the money supply is cheap (including but not limited to increasing salaries), consumption rises. This includes Fortune 500 companies as well as “Joe 6-pack”.
  2. Demand exceeds supply. As a result, prices go up. That’s inflation in a nutshell but that’s not the worst of it.
  3. Since demand is higher than supply, more workers are needed to produce product to meet demand. Loan money is cheap, so factories tool up to increase production on borrowed money. Salaries must increase to keep experienced workers because competition for a limited worker pool is intensified (supply vs. demand again. Works every time). Higher salaries and cheap money mean more demand for products - return to step 1.

It is a vicious cycle and can spiral out of control quickly. If you remember the days of 21% loan rates you know what inflation can do when left unchecked. Very few buisinesses or individuals prosper in that environment, especially banks - remember all the bank closures in the early eighties?.

It is a very difficult job the Fed has been assigned - keeping the economy for the entire US stable while not unduly afecting the individual. They make decisions that affect real people, both positively and negatively, but the over-riding concern is the good of the whole. The proven fact is that raising interest rates restricts the money supply, thereby slowing the demand side of the economy and easing inflation. Decreasing rates does the opposite.

Take an Economics course or two. It would do you good.

9

I’m going to agree with the good Doctor there…Greenspan knows exactly what he’s doing.

The economy right now is doing some pretty astounding things, unemployment, for instance, is about 4%, which, considering that the overall consensus prior to the 90’s was that the Full Employment level of unemployment was somewhere around 6%, is pretty damn astounding.

The truth is that the economy is at fuller employment than most people ever thought was possible, and it’s growing(as all economies go). Of course, this leads to a bit of nervousness is economists, after all, the Aggregate Supply curve is suddenly appearing to be different from how it was originally modeled-but no one is sure exactly how different it is. We could just keep growing at the current rate, sure, but then eventually we’ll go past Full Employment and inflation rates will shoot way way up.

Greenspan, by raising interest rates is simply trying to slow the economy (the only way he can, actually) so that it doesn’t overexpand and cause all sorts of nastyness.

(I’ve only ever taken one Econ course(and I failed it actually) and Greenspan’s actions make perfect sense to me. You really should take one or two.)

10

“Real wages never increase faster than inflation” – what a nonsensical assertion. Real wages do what they please regardless of inflation. Inflation is only a measure of the rate at which prices are increasing. Wages aren’t dependent on prices. If wages happen to rise faster than prices do, then real income increases. If wages rise slower than prices do, real income decreases. For the past few decades, on average, wages have been rising much more slowly than prices, but that doesn’t mean it has to be that way. On the contrary, one of the noteworthy features of our post-World War II manufacturing boom was the rate at which wage increases outstripped price increases.

As for Da Ace’s other assertion, the fact that our economy is now primarily service-driven rather than manufacturing-driven is one of the strongest factors behind the erosion in real wages over the last few decades. Manufacturing jobs paid a living wage. The majority of service jobs don’t. The ones that do require advanced education, which manufacturing jobs never did. So what happened to all the money that used to be paying our manufacturing workers? Well, in a nutshell, it’s gone into the pockets of the superrich and the bank accounts of foreign corporations, because we import so much more than we export. But that’s for another thread.

11

Why should one man have that much power?
Is there any way to fire him, or is he like a judge, in for life?

12

Um, he really doesn’t have that power honestly. He’s the leader(sort of) of the Federal Reserve, so he can muck with the interest rates, but thats about all. I would say that it’s similar to a position in the presidents cabinet, we’re just hearing a lot about him right now because of how the economy is doing. Besides, someone’s got to do it.

13

This is the text of an email I sent to a Doper in regards to another thread.

You often hear about “raising interest rates to fight inflation”. There are two kinds of inflation, good and bad, just like there are two kinds of cholesterol.

Good inflation is the result of economic growth. Essentially, more people are purchasing products, causing their suppliers to hire more, which causes the employees to make more money and consequently spend more. Prices are increased accordingly, resulting in inflation. This kind is the sign of a good economy up to a certain point.

The bad kind is caused when the value of money decreases because money is being bought and sold for a profit. When a large part of the economy depends on stock-market or currency-market speculation (remind me to tell you about the Bretton Woods accord some time) and on the making of interest on loans, the value of money goes down. That’s because money is being treated as though it had value itself, rather than merely representing value. (I can give you a more detailed explanation of this if you want.)

It would be like me selling you a two-foot ruler in exchange for a yardstick, and then you pretending that the two-foot ruler measured a yard. Suddenly everything would be one-third longer than before for you.

In other words, good inflation occurs because objects and services are worth more; bad inflation occurs because money is worth less.

Now then. Good inflation is good or at least not bad for working people because their wages are (ideally) keeping up with the cost of living, because the employer is making more profit and (ideally) passing it on to her employees. (The ‘ideally’ is why good inflation is only good up to a certain point.) It is bad for rich people with a lot of money socked away, because their savings are decreasing in value as prices increase.

Bad inflation is bad for workers, whose products are not worth any more than they were and whose wages are not increasing, and whose paycheque is worth less. Basically, high inflation = inability to borrow = inability to hire = unemployment and poverty.

It is however good for rich people, particularly moneylenders, currency speculators, and stockbrokers, who are causing the inflation in the first place.

Since the action in the economy is becoming dissociated from industry, the economy slumps even while people are making piles off of the stock market. This is the current situation.

Federal banks control the interest rates to regulate inflation, and have done since Milton Friedman introduced that theory circa 1973. The problem is that it only works on good inflation, not on bad inflation. The idea is that the higher interest rates are, the less people can afford to borrow, and so the less they can invest in their businesses, the less they can produce, the less they can pay their workers, and the less the economy can grow. This indeed reduces good inflation. But it doesn’t touch bad inflation. So the net result is a crippled economy, widening the gap between actual workers (the people who produce), who become impoverished and unemployed, and the rich stockbrokers, bankers, and speculators (people in nonproductive and inflationary “industries”).

In other words, the rich get rich and the poor get poor, and the middle class gets divided between rich and poor, depending on whether they are in a non-productive or productive industry respectively.

The effect of increasing interest rates on the general levels of unemployment can be predicted. That is what we mean when we say that the Fed keeps inflation down by keeping interest rates high and keeping people out of work.

A better way would require regulating the economy differently. For example:

  1. Decreasing interest rates. This would reduce banks’ profits on loans, reducing inflation from that source, as well as stimulate the real economy to hire, pay, and produce.

  2. Curbing currency speculation by such means as a Tobin Tax and a new Bretton Woods agreement.

I’m not sure how to deal with the stock market, but my research in this area is continuing.

For a more in-depth treatment of this, I commend to your readership Shooting the Hippo, by Linda McQuaig. It has a more Canadian focus, but basically she is to the economy what Carl Sagan is to astronomy. Very easy to understand.

14

You rule, Matt.

15

Thanks, Geenius. I try.

16

matt_mcl has some parts of this story right, but most of it wrong.

There is no “good” inflation, although the costs of moderate (say less than 10%) inflation are probably not that great.

Inflation may be associated with buoyant demand or with adverse supply shocks (demand-pull and cost-push inflation.

If the economy grows for a long period of time, particularly if financial wealth is accelerating, the aggregate demand for products can begin to outstrip the economy’s capacity to expand. Price pressure builds. So in a way, this inflation is symptomatic of a healthy economy.

The idea of restrictive monetary policy in this environment is to ensure that growth is sustainable: rapid booms tend to be followed by deep recessions. What Greenspan is trying to do is to slow the economy back to a sustainable growth path.

The “bad” inflation matt_mcl talks about is in a way the financial flipside of a growing economy: as the economy grows, wealth is generated and people start to spend out of this wealth and the wealth they think is coming.

Really bad inflation comes from adverse supply shocks, like OPEC (unless you were an OPEC member, in which case yopu were probably pretty happy, although some “good” inflation probably accompanied your profits. This is where the costs of production rise, pushing up prices and pushing down real wages.

I must make it clear that Greenspan’s policies not only are not those of Milton Friedman, but that they are pretty much exactly the opposite of Friedman’s.

Firstly, Greeenspan suggests that the conduct of Monetary policy is through interest rates. Friedman said that the quantity of money should be targeted. Anyone who believes that the monetary transmission mechanism operates through general financial channels id NOT a monetarist.

Secondly, Friedman advocated a monetary rule which would be something like: “increase the money supply at 3% a year, whatever happens”.

This is obviously a passive policy, and it comes from Friedman’s belief in the inherent stability of the economy. (He believes for example that the Great Depression was caused by the Fed.) He would not advocate doing anything different in the current circumstances.

Greenspan on the other hand is pursuing an active monetary policy: he is trying to stabilise the economy.

With respect to your two points matt:

Point 1. is just plain wrong. See my earlier post in this thread. You seem to assume that there is always unused productive capacity in the economy that can be brought into play without exerting inflationary pressures. This is true in a recession, but not now in the US.
Point 2 comes in two parts. The Tobin tax, for those who don’t know (most I guess) is a proposed tax on the turnover of financial markets to reduce excessive volatility. Whilst it may be a good idea, it would not eliminate the need for monetary policy, although the inflationary concerns in the US of the last year or so would arguably have been lessened, since the NASDQ would have gone on a somewhat less wild ride.

Bretton Woods was the old fixed exchange rate/ currency controls/ World Bank/ IMF agrreement at the end of WWII. The recent experience of fixed exchange rates (Indonesia etc) have been a disaster. They do not solve the problems of floating exchange rate economies, they just admit the shocks in a slightly different (and almost always catastrophic) way. In any case, I doubt that it would be possible to reimpose exchange controls.

This getting too long now, so I’ll stop.

picmr

17

I’ve only just noticed where this thread is: can it be moved to Great Debates?

picmr

18

Oops. You’re right; I didn’t say what I meant to say, and what I did say was stupid and wrong. Thanks for catching that.

Let’s try again: when wage growth is driven by inflation (i.e., in a situation unlike the present day, where inflation is minimal), wage growth always lags behind inflation, and generally does not quite keep up with inflation. Result: lowered purchasing power. My point was that inflation is not good for the working class; they tend to get hurt the hardest because they have the least ability to shift assets and income.

That wasn’t my point (though it is one possible explanation for the lack of inflation – workers not having the clout to get major wage increases). My point was that the engine of the current expansion was the high-tech sector, where prices have a strongly downward trend. I postulated that was helping to keep inflation in line.

19

Only in the sense that the costs of services are largely independent of the costs of raw materials. When the costs of materials go up, the manufacturing sector has to raise its prices. The service sector is a little more flexible.

But the assertion that “when wage growth is driven by inflation [you mean when inflation is driven by wage growth, don’t you?] wage growth always lags behind inflation” is just false. It has been true recently, in this country, under a particular set of circumstances. As long as the ongoing transfer of wealth to the superrich from everyone else continues, it will almost certainly continue to be true, because in such a situation the money to pay workers never comes out of anyone’s pockets but other workers’. But it is not an inviolable economic formula. The simple game of follow-the-money proves it.

I strongly recommend that you read Cities and the Wealth of Nations by Jane Jacobs. She wrote it as a study of the causes of “stagflation” (the “economically impossible” combination of inflation and economic contraction), but it also has a lot to say about our current situation, which is almost the polar opposite (negligible inflation and wild economic growth).

20

Nope. I mean when inflation (you know, prices going up?) drives wage growth (workers agitate for increases in salary because inflation is making their pay worth less), it never quite keeps up. Not at all what you’re saying. But it does speak to your original point about the “superrich” being the only ones really hurt by inflation; it’s just wrong.

You keep going off on your own tangents, which is fine, but please at least notice that you’re wandering off the subject.

Most of the money of the new “superrich” basically came out of nowhere (and I tend to think that to nowhere it shall return), rather than from anybody else. The biggest engine of wealth over the last decade has been NASDAQ, not any manufacturing industry (or anything much tangible at all). Joe Sixpack has had very little to do with it, which may be one reason why he hasn’t benefited much (except as much as he’s an investor in the stock market).