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Saturday, June 19, 2021

The Case For (Very Gingerly!) Raising Interest Rates Now

Inflation seems to be back.  Not severe (yet), but some experts are concerned nonetheless.  The very long-term risk is still in the direction of deflation, as we have argued before, but the short to medium-term risk now seems to favor inflation.  And inflation is fundamentally caused by shortages, not "money printing" like the fiscal hawks luuurrrrve to claim.

The solution, however, is NOT to implement austerity measures, which only cause recessions and depressions. Rather, as Rodger Malcolm Mitchell notes, the solution is for the federal government to spend more money to alleviate the shortages.  Whatever there is a shortage of, they can buy at a premium and sell or give away at a loss, thus incentivizing production.  Everything from lumber to labor can be alleviated this way.   In the case of labor, they should permanently replace long and generous unemployment benefits with a no-strings-attached UBI for all and perhaps also a "reverse payroll tax" (aka wage subsidy) for workers.  And shorten any future unemployment benefit claims to a maximum of 13 weeks per benefit year going forward.  

Problem solved. 

But what about inflationary expectations, where both demand-pull and cost-push inflation seem to feed on itself in a vicious cycle? The solution is simple again: the Fed can raise interest rates.  The TSAP supports tapering off QE and very gingerly raising the Fed Funds Rate from it's current 0% to 0.5% immediately, then to 1.0% shortly after, then gradually by 0.25% every few weeks until the inflation rate drops below 3% or the interest rate exceeds the inflation rate by 1%, whichever occurs sooner.  Then once inflation is beaten, they should drop the interest rate to below the inflation rate and park it there until inflation heats up again as leaving it too high for too long can make cost-push inflation worse.  That should quickly nip any inflationary expectations in the bud right away.

But we should not let inflation be an excuse to avoid progressive priorities, and should certainly avoid austerity measures or any tax hikes at this time, except on the top 1% and especially the top 0.1%.  The economy is booming due to both reopening as well as the various stimulus measures, but the recovery is as fragile as it is K-shaped and uneven.  So let's not screw that up!  And most certainly, never lock down again!

AUGUST UPDATE:  The TSAP now recommends tapering off the current "not-QE-but-most-certainly-QE" much quicker and also raising interest rates (Fed Funds Rate) immediately to at least 0.5-1.0%, as inflation still seems to be accelerating and does not seem to be automatically curing itself.  Also, the Fed should quickly restore the reserve ratio to 5% and then 10%, and if that still doesn't work, raise interest rates further and/or resume Quantitative Tightening (QT).  The sooner they act, the less inflation there will be.  So what are they waiting for?

For fiscal policy, the extended and expanded unemployment benefit payments are soon to be yanked automatically, and all that suspended rent for millions of people has just abruptly come due, so for better or worse that should cool things off a bit.  Any further rent relief for those who still need it should come in the form of temporary direct payments to landlords, not eviction moratoriums.  If there is to be a debt jubilee it should be for everyone, not just some people.  And a tax hike on the top 1% and especially the top 0.1% would be good to do.

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