Thursday, January 14, 2010

Why higher inflation is no help

A comment on Andy Harless' recent post.

Andy considers several Fed target options, and chooses a somewhat higher inflation. But selecting higher inflation in order to give the Fed more distance from Zero Bound is not going to work.
I go through this many times. Inflation broadens the distribution of price elasticities, and the economy does not have the accuracy to precisely price rare goods under such a broad distribution. Research indicates to me that about 20% of inflation is monetary, the rest appears as relative price changes.

Inflation expands the trading price variation for goods., we end up with more price variation then needed by finite number of goods. The natural tendency of the economy would be to deflate, reduce transaction rates, lower the number of transaction stages, and increase lot sizes. Bankers cannot achieve purely monetary inflation, but if they could the result would be an unnecessary deflation tendencies.

The Fed needs to target the bankers yield curve for maximum entropy.

No comments: