Monday, September 13, 2010

Bretton Woods Research on Fed policy.

The following is a comment from Vlad Signorelli at Bretton Woods Research on The WSJ's recent forum, "What Should the Fed Do Next?" It's available for subscribers here.

The Wall Street Journal has a special oped symposium today devoted to the question about what Fed policy should be going forward given the weak economy and the perception of deflationary risks. Today's monetary experts weigh in, such as John Taylor, Richard Fisher, Rick Mishkin, Ron McKinnon, Vincent Reinhart and Allan Meltzer. Their recommendations range from doing nothing to monetizing more debt (inflating), or reverting to a rules-based interest rate policy like the Taylor Rule. They each get the answer wrong.

The best thing that the Fed could do is to abandon this endeavor of seeking to grow the economy, while maintaining a policy of price stability that is based on highly flawed inflation statistics. Instead, it should adopt a rules-based dollar policy by announcing a plan to target a specific dollar-gold price, perhaps at $850 or lower. By doing so, the inflation-deflation concerns would be substantially mitigated. Then, to address weak growth, Congress should permanently extend low tax rates, and ideally eliminate corporate and capital gains taxes.

This dual approach would solve the stagflation risks facing not only the US but global the economy, which the conventional Keynesians are completely missing. Like the 1970s, their models do not know how to properly diagnose and remedy such an economic predicament because slow growth and inflation are not supposed to happen based on Phillips Curve theory.

Even though the Republican's electoral prospects look outstanding these days, some polls show that the American people still don't trust the GOP to manage all of the country's economic affairs. From our classical economic perspective, we believe the reason lies in the fact that Republicans, despite their relatively better fiscal proposals, have little clue about monetary affairs -- just like most of the politicians and economists involved in our country's economic policymaking. The Tea Party, which sprang up in reaction to the monetary and fiscal response to the financial crisis, is an example of the anger in grassroots America about these modern-day Keynesian failures.

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