Progressives Should Get to Know Monetary Policy

In sociology, conflict theory is an analysis that emphasizes the economic, social or political inequality of a particular social group. When some conservatives in the U.S. claim that there's a class war on the rich, they are applying conflict theory - albeit the inverse of their conclusions is correct. There's a conflict theory analysis to be made of inflation fears and Gov. Rick Perry's attack on the Federal Reserve. To be brief, one major thing the Federal Reserve, or the Fed, controls the money supply - basically, how much money is available to the entire U.S. economy. It does that by trying to set a certain interest rate on short term loans to banks - lower interest rates generally mean more money. General interest rates of various terms will track the short term rates to some extent (with longer loans almost always having higher interest rates than short term ones). This is a gross and inaccurate oversimplification, but you can think of it as the Fed setting a target interest rate. If you're interested in what the Fed actually does regarding the Fed funds rate, read this article and this one. I'll argue that the Fed should be going for higher inflation, which could help stimulate the economy - but that higher income individuals are more hurt by inflation than unemployment (whereas the poor are hurt worse by unemployment than inflation). That's the class conflict that's behind the crank monetary policy ideas that some on the American Right espouse. Note, though, that macroeconomics and monetary policy isn't my primary expertise, so I may be off on some descriptions - but I think the general thrust is consistent with what some progressive economists would believe. The Fed, and most central banks, has two goals: to control inflation and to minimize unemployment. When the economy enters a recession, the Fed reduces interest rates - this makes it easier for businesses and consumers to borrow money. Not that anyone should be doing so with wild abandon, but this makes businesses and consumers more likely to spend. When the economy heats up, the Fed increases interest rates, gradually. If inflation is too high, the Fed will also raise rates. Keynesian economists argue that a certain amount of inflation is consistent with an increasing level of aggregate demand - the more people who are employed and the more that they are paid and spend, the greater the demand for stuff, which causes inflation. If lots of people are unemployed, it's probably going to be difficult to have high inflation unless there's a different cause, like war in the Middle East causing oil prices to spike. On that last bit, there's an argument that higher inflation would reduce unemployment. Matthew Yglesias sums it up:

Higher inflation expectations would have a number of benefits. For starters, they would reduce real interest rates, mitigating the problem of the zero lower bound on nominal rates. They would also increase the cost of hoarding cash. This would encourage wealthy individuals and cash-rich firms to purchase real goods and services, or else invest in productive assets. Last, since mortgage debt is denominated in nominal terms, a faster rate of inflation would speed the deleveraging process and let households repair their balance sheet.

Here's an explanation of the bolded words, which are my emphasis - "Reduce real interest rates": Right now, interest rates on all sorts of debt are pretty low. As I said, they tend to track the rates the Fed sets in the Federal funds rate. Generally, you want to reduce rates to stimulate economic activity. However, the Fed funds rate, which is the only one the Fed directly controls, is just about zero - the "zero lower bound." The Fed can't reduce interest rates directly, but if they were to target higher inflation, it would have the same effect - if you're earning 5% in a savings account and inflation is 1%, you're doing pretty well, but if you're earning 5% and inflation is 4%, you're barely breaking even. Same thing if you're the debtor, rather than the saver. "Increase the cost of hoarding cash": Higher-income individuals save more than lower-income individuals. If the rich folks were to spend more, that would help the economy (all else equal), because businesses would hire more workers to meet the additional demand. It might not be immediately obvious, but if inflation is higher, you might as well spend, because your money will be worth less next year. That influences decisions at the margin. "Mortgage debt is denominated in nominal terms": One of our big problems right now is that lots of people have high amounts of mortgage debt, thanks to the housing bubble (i.e. thanks to the idiots on Wall Street). As I alluded to earlier, higher inflation erodes the value of debt. And it turns out it's a stealth way of reducing the burden of mortgage debt. Now, the Fed doesn't have any direct levers to cause higher inflation. To some extent, though, them just saying that they're targeting higher inflation may well work, as businesses and individuals anticipate higher inflation. They can also just go out and buy however much bonds or other financial assets they want to, a policy known as quantitative easing. The Fed won't actually be spending any taxpayer dollars - it will just be using its administrative authority to buy stuff, usually from banks. When it does this, it injects more money into the system. There are probably some less conventional policies they could do which I'm not familiar with, but that this Wikipedia article tries to describe. As I alluded to in the intro, the interests of the rich diverge from the rest of the country. Higher income Americans usually have a lot more financial assets, like stocks, bonds, money in the bank. They will just about always be less likely to be unemployed that the average American, and especially than the poor. However, most low- and moderate-income Americans have little in the way of financial assets. They're barely making ends meet - why do you think there's a payday loan industry? They're also more likely to be unemployed - much more likely, if they have less than a high school education or GED. In other words, the rich are more hurt by inflation than by unemployment. The poor are likely to be hurt more by unemployment than by some inflation. To be clear, I'm not arguing for hyperinflation. I'm saying, though, that we should be willing to accept higher but manageable levels of inflation, if they stimulate the economy. Unfortunately, the monetary cranks have the better of the monetary policy debate right now. They're accusing the Fed of "debasing the currency." They're arguing, as Gov. Perry did, that the Fed is rampantly printing money, as if that will cause government profligacy. They say that the Fed is hurting retirees on fixed incomes. The thing is, though, that we're not experiencing inflation. Having the dollar 'weaken' with respect to other currencies will increase our exports - if we have a 'strong' dollar, then it's harder for other countries to buy our stuff, and if they can't, then that's detrimental to the recovery. Inflation is not that high right now. And Social Security, which is a significant source of retirement income for most Americans, is inflation protected. In other words, there's significant reason to believe that the cranks are wrong: inflation isn't very high right now, and if we could probably withstand some inflation (in the 4% range), if it boosted the economy.