Inflation targeting in a 0% realm

There has been a proposal floated to set a Fed inflation target tied to unemployment. The upside is that this could be done simply via a vote of the Federal Reserve board, since this is within the purview of the authorizing legislation for the Federal Reserve. The downside is that it wouldn't work.

Look: I can see why the idea appeals to some people. It completely side-steps the legislative log-jam in Congress. The problem, however, is this: How is the Fed going to create inflation when it already has reduced real interest rates to 0%? Once you hit the 0% boundary, you're basically stuck -- you can't reduce real interest rates below that, because people simply aren't going to pay banks to keep their money in the bank. They just won't. They'll stash their money under mattresses instead, and at that point you're talking about bank collapses and a massive deflationary spiral and a world of hurt.

Now I hear the acolytes of Milton Friedman crying, "what about helicopter drops?!" But what we've seen over the past three years is that helicopter drops -- the Federal Reserve printing money with all the abandon of a Wiemar Republic finance minister -- only accomplishes creating inflation in China and in oil prices. That's because the money gets into the consumer's pocket and the consumer either spends it in China -- since pretty much all he wants to buy is in China -- or he spends it on gasoline to get to work -- since demand for gasoline is inelastic (you don't have any choice but to burn it to get to work) the oil companies can simply increase their prices to suck that money right back out of the workers pockets, and there's nothing that workers can do about it, if they want to work they *have* to drive in the 98% of America that has no functional mass transit system. Then once the oil companies get it, what do they do with it? Well, they either spend it overseas -- which is no help at all to America and Americans -- or they stash it under (virtual) mattresses where it effective disappears from the economy -- again doing nothing to employ the 20%+ real unemployed Americans, and until you get a significant number of those Americans re-employed you *can't* see significant wage inflation, because there's simply too much supply and not enough demand for workers.

So you can't lower interest rates right now, and you can't print money, so how could the Fed create a realistic expectation of inflation? Answer: They can't. All that would happen if the Fed made such an announcement would be widespread laughter, because anybody who's serious knows that Keynes may have been wrong about a lot of thing, but he was utterly correct about what happens at the 0% boundary -- at the 0% boundary monetary policy becomes utterly ineffective, and you must then rely on fiscal policy (i.e., the government directly buying or hiring to create employment in America for Americans) to soak up the surplus workforce, trigger wage inflation, and get things to the point where monetary policy *could* be effective.

Which, given that we're currently in the grips of an Austerian religious ideology which holds that fiscal stimulus is evil, means we are seriously, totally fucked.

-- Badtux the WASF Penguin