E Sane And Silly Economics From Sumner, Yellen And The BIS

Scott Sumner, well known market monetarist, discusses Janet Yellen's procyclical bias on a recent post at The Money Illusion blog. He believes that Yellen's experimental idea to let inflation run hot in an expansion would be a mistake. Three percent inflation, Sumner says, while unemployment is low, would ultimately destabilize the economy. You could argue about how low unemployment is. But let's say Prof is right for the purposes of this article.

Before I talk about Sumner's comments that make sense, I would like to speak to a comment he makes that I disagree with, that may prove to even be as silly as some Fed and BIS talk. Sumner said: 

Yellen’s statement was not an indication of Fed policy, but merely the musings of one person.  It’s very unlikely to be put into action.  And yet bond prices plunged. Now imagine if all 12 members of the FOMC got on a stage and said they were raising the inflation target from 2% to 3%.  The impact on the bond market would have been at least 10 times greater than what occurred yesterday.[Emphasis mine]

I disagree with the last sentence of that quote. I am skeptical, because of the conundrum, that the Fed has the power to bust open long yields upward. I think increases would be short lived, and a massive buying opportunity for bond investors. It seems to me that Scott Sumner and most market monetarists, and most economists, do not take seriously the conundrum caused by massive bond demand as collateral. I still believe that there is a solution for this long bond problem, which is shared at the end of this article. Monetary policy is simply aimed at the wrong entities.

And I am thinking that the Fed would not even up the target to 3% in a downturn. Until someone shows us otherwise, the Fed behaves as if it is in a straight jacket of derivative insanity. It is useless to talk to Professor Sumner about this issue of bond demand because he is mum. You have to wonder why. And Yellen is just talk, if, as Sumner says, the rest of the governors would never impose the 3% target. The bond market seems to be rigged by Fed talk, and by bank manipulation, to push yields on the long bond up incrementally, but only to create buying opportunities.

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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