Friday, December 18, 2009

Why Have Prices Increased?

The price level has nearly doubled during the "Great Moderation."

Why? Is it just a law of nature?

No. The price level rose because the Federal Reserve wanted it to rise.

While they prattle on about their dual mandate of high employment and stable prices, their actual policy is to engineer inflation--about two percent each year.

Economists are discussing the "problem" that inflation is "too low." Over the last year, it has been well below the 2% trend that the Fed had engineered. Perhaps it should be hiked to 3%, the level of 2004 and 2005?

But that isn't the real problem. The real problem is that nominal expenditures are too low.

It is possible that a policy of returning nominal expenditures to the previous growth path would result in temporarily higher inflation. But the purpose of the policy isn't to generate higher inflation. It is rather to raise nominal expenditure, increase sales of consumer and capital goods, expand the production of consumer and capital goods, expand employment producing those goods, and reduce unemployment. Any inflation resulting from the policy is an undesirable side effect.

More importantly, a shift to a three percent growth path for nominal expenditure would keep the price level stable over the long run, with temporary inflations and deflations matching changes in productivity. Instead of seeing the price level double over the next 25 years, it would remain roughly constant--price stability.

1 comment:

  1. As said, it is because of Fed wanted to rise, but we need to be careful with how we go about things. I always follow these news from Fed strictly, as we know how much it matters in the market and if we go against these stuff then we might lose badly. I have perfect broker in OctaFX, so their highly qualified teams of experts do the job for me, as I get daily reports of market and simply following that with wise money management leads to profits.