Eric Rosengren winks at the 4% Club. The FOMC member devotes most of his speech to credit easing but notes
While lower long-term rates are likely the primary channel through which asset purchases would influence the economy, purchases of Treasury or mortgage-backed securities also expand the Federal Reserve’s balance sheet and increase the amount of reserves in the financial system. This expansion of reserves might serve as an effective signal that highlights the determination of the Federal Reserve to reduce disinflationary pressures.
Note he didn’t say deflationary pressures. He said disinflationary pressures. Disinflation refers to reductions in the rate of inflation. Rosengren is telling us that the Fed is determined to fight reductions in the rate of inflation and that it has the balance sheet to prove it.
America, however, is a wounded lover. She knows you love her but she needs to hear you tell her that you love her. She needs your words. Is the Fed going after an inflation target?
Why does that matter?
It matters because an explicit statement by the Fed produces credible expectations. Some people are confused by this. They think actions should count louder than words. Words are just promises.
I won’t do my full, full song-and-dance on this but the entire financial economy is just promises. Investment Bankers are in the business of selling promises. Investors are in the business of buying promises. Traders are in the business of swapping promises. Your mortgage is just a promise. Your credit cards are little promise makers.
Even the cash in your pocket is just a joint promise from the Federal Reserve and the US Judicial System. It says so right on the little promissory note: Legal Tender for All Debts Public and Private. That is, we promise to let you out of your obligations if you turn over enough of these little slips.
All things financial are ultimately promises.
Promises, however, matter. Ultimately they matter because promises are how we coordinate people to make stuff that is bigger and better than any one person could make alone. If we couldn’t make promises to each other we could never build factories, homes, cars, etc. In truth specialization would all but collapse and the modern economy would cease to function.
Many economists like to pretend that the economy functions on the basis of trade. The baker makes bread and trades with brewer who makes beer. But, this isn’t how the real world works is it? The real world is full of promises.
When the baker wants beer he give the brewer a promise. When brewer wants bread he gives the baker a promise. If they don’t trust each other very much they trade in government promises, that’s called legal tender or money. When they trust each other a lot they trade in private promises, that’s called credit.
I have occasionally received gifts in appreciation for my lectures but mostly I receive a big chunk of promises at the end of every month. I use those promises to meet other promises that I have made. And, with the promises I have left over I can get other things that I might want for the month. I keep some of my promises stored away, as a promise to myself.
In the old days when even trust in the government was low promises took the form of metal. For most people the metal had little value but they knew someone else might want it so it was good enough. Today, trust is high. Our legal system is strong and most promises are just bits in a computer system, a little electronic maker that says society promises resources to John Doe. Promises are the foundation of our economy. That’s why when promises go bad, as they did in the sub-prime crisis, the whole economy goes bad. That’s why some of think the government needs to make some new promises. We are running short.
An explicit inflation target is a verbal financial contract or promise to America and as long as the Fed has some credit worthiness that promise has value. It says:
- We, your monetary authorities, promise to continue to push out aggregate demand until sales volumes are rising faster than otherwise would have been expected and businesses are forced to increase the rate at which they raise prices. We make this promise to you knowing that the intermediate effect will be for businesses to try to meet market demand at the current inflation rate and thereby lower unemployment.