Comment at Economist's View

Just posted this:

Back in 2001 we suffered because of the tech boom and now we will suffer because of the subprime meltdown.

In both cases, inflation remained (relatively) benign and the Fed kept rates low... until inflation began to be a problem and the Fed raised rates. A bust followed.

It is obvious that current monetary policy is unable to solve this problem. The Central Banks focus upon Consumer prices as the key to adjusting monetary conditions. The problem with this is that, in both 2001 and 2007, a massive asset-price increase preceded the bust. Even though inflation remained low, the massive rise in stock prices (the years up to 2000) and the massive rise in property prices (the years up to 2007) did not figure in inflation. Therefore the inflation that caused both busts (I am talking in the past tense about the bust we are undergoing now) was not factored into the Fed's monetary actions.

The best solution is, to my mind, having a stricter inflation target that the Fed (and all central banks) aim for. If increased rates were needed between 2001-2004 then, in hindsight, the only way the Fed could have acted to achieve this would be to have a lower target. In other words, rather than acting only when inflation starts heading above 2.5%, it may have been more prudent to act when inflation starts heading above 1.5%, or even lower.

Of course, having higher rates between 2001-2004 would have stifled economic growth - but the result would have been lower growth over a longer period, rather than having boom and bust all over again.

As we all know, monetary policy was introduced as an inflation controller because of the booms and busts of the 1970s. Although much of the 1970s was a result of oil shocks, inflation figures between 1964 and 1970 were too high by modern standards, so the recession in the early 1970s was going to happen, oil shock or not.

It now seems that monetary policy, in its current form, has not solved the boom/bust problem. Indeed, the world has suffered three major economic crises since the early 1990s recession - the 1997 Asian economic crisis, the tech-bust of 2000 and the Subprime meltdown of 2007.

Unless central bankers are willing to set harsher inflationary targets, and restrict monetary growth such that Consumer prices do not increase annually by 1% or more, I would say that this boom/bust situation will continue.

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