Yellen's Implicit Inflation Target

Janet Yellen, President of the San Francisco Federal Reserve Bank, who previously preferred an inflation objective of 1.5% in the long run, has changed her preference to 2%. A higher inflation preference is interesting coming off a period of history economists called "The Great Moderation" - a glorious time of low inflation, low unemployment, and steady growth. The higher inflation preference of Ms. Yellen is meant to give the Federal Reserve more room to respond to shocks. Indeed, the current deflation fears has caused the Fed to lower the Fed Funds Rate target to a range of 0% to 0.25%, which leaves little room to maneuver if the economy were to continue to deteriorate. A higher long run objective would give the Fed more room to cut. In Ms. Yellen's words:

“Thus, an analysis of the zero bound needs to incorporate greater volatility than experienced over the past quarter century. With respect to the equilibrium real interest rate, the global savings glut that helped restrain real interest rates may persist or even intensify after the recession is over, leaving us with only a small cushion against reaching the zero bound.”

Economic Myth Busters - Spending vs. Saving

vs.

There has been much talk recently about the benefits of spending during times of recession. The message that is often communicated is that spending causes growth and is good for the economy while saving does not cause growth. Even Nobel Laureate Economist Paul Krugman makes this claim...

If the money the government lays out doesn't get spent—if it just gets added to people's bank accounts or used to pay off debts—the plan will have failed.
—Paul Krugman (New York Times, Jan. 25, 2008)

Tobias Madden, an economist at the Minneapolis Federal Reserve, does a nice job of busting this myth. Madden says that saving does have economic benefits...

Saving provides an important source of capital to banks and companies. In particular, banks utilize consumer savings to make loans to individuals or companies, and public companies use consumer investments to build factories, hire new employees, research new products and so on. Saving drives all of the above. If an individual wants to take out a loan to buy a car, the bank can use the savings of consumers to make a loan to that individual. When a bank makes a loan, the person or business receiving the loan will spend the money, which is the secondary spending that takes place to aid economic growth. However, it may take time to make this investment and for the effects of the investment to roll through the economy.

Saving in the present creates stronger spending in the future. When consumers save, they earn interest on their savings and experience appreciation on their investments. When interest is received and profits are made, consumers have more income to spend than they had prior to the investment. When U.S. taxpayers received their tax rebate checks, spending them immediately may have had the greatest effect at the present; however, saving that check would have accrued interest and appreciation, creating greater spending power in the future.

University of Delaware Commencement

I was in Newark, Delaware over the weekend attending my graduation from the University of Delaware. I finished my M.A. in Economics and Entrepreneurship for Educators. Thomas Friedman gave the commencement address and did a nice job.

There were 3400 graduates at the ceremony and I was happy to be there.