Chart of the Day #2: The Deflation Trap

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This chart comes from Seven Faces of ?”The Peril,” ?a paper by St. Louis Fed president James Bullard. Bullard has generally been considered an inflation hawk, but in this paper he describes a technical problem with inflation targeting. Most central banks follow something called the Taylor Rule, in which interest rates are raised when inflation gets too high and lowered when things cool off. But Bullard notes that a standard model of the Taylor Rule has two points where it’s in equilibrium — in the chart below it’s where the red line meets the black curve. The one on the right is fine: it corresponds to an interest rate of about 2.8% and inflation of 2.3%. This is roughly where the U.S. has been until recently. But the one on the left is trouble: it corresponds to an interest rate of zero and deflation of about -.5%. This is where Japan has been.

Bullard’s conclusion is simple and direct:

The U.S. economy is susceptible to negative shocks which may dampen infl?ation expectations. This could possibly push the economy into an unintended, low nominal interest rate steady state [i.e., deflation]. Escape from such an outcome is problematic. Of course, we can hope that we do not encounter such shocks, and that further recovery turns out to be robust? but hope is not a strategy. The U.S. is closer to a Japanese-style outcome today than at any time in recent history.

….To avoid this outcome for the U.S., policymakers can react differently to negative shocks going forward. Under current policy in the U.S., the reaction to a negative shock is perceived to be a promise to [keep interest rates] low for longer, which may be counterproductive because it may encourage a permanent, low nominal interest rate outcome. A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.

The problem we have right now is that if you grind through the usual arithmetic of the Taylor rule, what pops out of the formula is a negative interest rate. But interest rates can’t be negative. So for all practical purposes, monetary policy right now is quite tight even with interest rates at zero. What Bullard suggests is that if the economy suffers any further shocks, the Fed needs to respond even though it can’t lower interest rates any further. And the way to do that is to fire up the printing presses.

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SIX TRUTHS

Reclaiming power from those who abuse it often starts with telling the truth. And in "This Is How Authoritarians Get Defeated," MoJo's Monika Bauerlein unpacks six truths to remember during the homestretch of an election where democracy, truth, and decency are on the line.

Truth #1: The chaos is the point.

Truth #2: Team Reality is bigger than it seems.

Truth #3: Facebook owns this.

Truth #4: When we go to work, we're in the fight.

Truth #5: It's about minority rule.

Truth #6: The only thing that can save us is…us.

Please take a moment to see how all these truths add up, because what happens in the weeks and months ahead will reverberate for at least a generation and we better be prepared.

And if you think journalism like Mother Jones'—that calls it like it is, that will never acquiesce to power, that looks where others don't—can help guide us through this historic, high-stakes moment, and you're able to right now, please help us reach our $350,000 goal by October 31 with a donation today. It's all hands on deck for democracy.

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