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**Unlinozistimi** · 10-28-2009, 01:07 AM

Japher, that's always how the fed controls inflation. They manipulate interest rates, which changes the money supply

Spencer, the reason that the fed has increased the money supply so much is that the banks (and others) have deleveraged greatly over the past little while, while monetary velocity dropped like a rock. As those conditions begin to reverse themselves the fed will increase interest rates, decreasing the money supply and attempting to maintain the US on a relatively stable inflation path. This problem is what's become referred to as the fed's "exit strategy". Luckily, the fed has all the tools it needs to do this in a relatively responsive way. I wouldn't be surprised if they under- or over-shoot slightly, due to the scale of the disruption, but in general it will be handled quietly and effectively.

The real problem in the 70s was that there was such high inflation for so long that inflation EXPECTATIONS had gone way up. People expected prices to increase, so they increased their own prices. To reverse these expectations, the Fed had to take drastic steps. Inflation expectations are nowhere near where they were. In fact, the US is still teetering on the brink of deflation.

This brings up the idea of one reason why deflation is a more troubling effect than inflation; there is a lower bound to interest rates, namely 0% (if you attempt to reduce it below that people simply move into cash, which returns 0%). The fed is impotent, using standard open market operations, to counter deflation when interest rates are at 0%. There is no such problem on the upside.

EDIT: meant "interest", had written "inflation"

10-28-2009, 01:07 AM	#3
Unlinozistimi Join Date Oct 2005 Posts 414 Senior Member	Japher, that's always how the fed controls inflation. They manipulate interest rates, which changes the money supply Spencer, the reason that the fed has increased the money supply so much is that the banks (and others) have deleveraged greatly over the past little while, while monetary velocity dropped like a rock. As those conditions begin to reverse themselves the fed will increase interest rates, decreasing the money supply and attempting to maintain the US on a relatively stable inflation path. This problem is what's become referred to as the fed's "exit strategy". Luckily, the fed has all the tools it needs to do this in a relatively responsive way. I wouldn't be surprised if they under- or over-shoot slightly, due to the scale of the disruption, but in general it will be handled quietly and effectively. The real problem in the 70s was that there was such high inflation for so long that inflation EXPECTATIONS had gone way up. People expected prices to increase, so they increased their own prices. To reverse these expectations, the Fed had to take drastic steps. Inflation expectations are nowhere near where they were. In fact, the US is still teetering on the brink of deflation. This brings up the idea of one reason why deflation is a more troubling effect than inflation; there is a lower bound to interest rates, namely 0% (if you attempt to reduce it below that people simply move into cash, which returns 0%). The fed is impotent, using standard open market operations, to counter deflation when interest rates are at 0%. There is no such problem on the upside. EDIT: meant "interest", had written "inflation"
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