American consumers are busy deleveraging. Too many people owe too much money, and they are busy paying down old debt rather than buying new things. This is salutary in many ways. But it’s also the biggest drag on the American economy and is likely to remain so for years, if something is not done. Wouldn’t it be nice if there were things the government could do to decrease the dragging effect of this debt, even if just a bit?
There are. One of them would be for the Federal Reserve Board to raise its inflation target from its current 1.5 to 2.0 percent to something modestly higher, perhaps 3 or 4 percent. Because wages and earnings typically keep pace with (or exceed) the inflation rate, this would allow working consumers to pay off more debts faster. Many prominent economists have called for the Fed to do exactly this. Ken Rogoff of Harvard, Paul Krugman of Princeton, and many others. But the Fed has so far resisted, to the puzzlement of many.
The New York Times has a terrific article explaining what’s been happening inside the Fed and why it resists calls to further loosen the reins on the money supply. The short answer is that the modest increase in inflation necessary to speed along consumer deleveraging would reduce the assets of the biggest financial institutions in the country — credit card issuers, mortgage lenders, et al. Many of these institutions are the same ones that played a role in causing the financial crisis in the first place. Perhaps Obama should appoint new Fed governors to fill the two open slots who are as interested in restarting the economy, as they are in protecting the banks:
. . . Mr. Bernanke knows that if he errs on the side of passivity — worrying more about inflation risks than unemployment — he risks only a modest flogging from colleagues and politicians. If he leans the other way, he risks being accused of, well, treason.
. . . Why does the Fed skew more hawkish than the economics profession as a whole? Part of the answer lies in the way the 12 voting members of the policy-setting committee are chosen. They are a mix of presidential nominees subject to Senate approval, with 14-year terms, and regional Fed presidents, who are chosen by outside boards that are made up partly of private-sector finance executives.
David Levey, a former managing director at Moody’s and another critic of Fed inaction, points out that banks often have more to lose from inflation than from unemployment. Inflation reduces the future value of the money that their debtors — homeowners, car buyers, small businesses and the like — will repay them.
“The Fed regional banks represent, in essence, the banking community, which tends to be very conservative and hawkish,” Mr. Levey says. “Creditors don’t like inflation — [because] it’s good for debtors.” Indeed, the three recent dissents all came from regional bank presidents: Richard W. Fisher of Dallas, Narayana R. Kocherlakota of Minneapolis and Charles I. Plosser of Philadelphia.
Note that Rick Perry is famously opposed to monetary easing, suggesting that it would be “treason[ous]” for Fed chief, Ben Bernanke, to do more than he’s done so far. Perry is more of an inflation hawk even than current members of the Fed.