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Barney's Inflation Inquiry



February 16, 2007 – Comments (0)

While trying to ignore the bloodbath in my CAPS portfolio (see previous post) I was thinking again about the much publicized question that Barney Frank posed to Big Ben (that's Bernanke) yesterday. In short, he said:

"Dude, what's the deal with inflation, did it make fun of you as a kid? Why aren't we focusing more on economic growth?"

For Mass. citizens, don't worry, he phrased it in a much more Congressorial (is that a word?) fashion. In any case, even though I was a economics grad back in college, it took me a bit to ponder the question. I haven't really been mulling it over too much over the past couple years since it's easy enough to just say "inflation bad."

On the one hand, inflation is a good marker for how well we're doing at staying on a sustainable growth path. When inflation starts rising too fast it typically means there's too much competition for resources and workers and the economy is in over-capacity mode. Working over capacity can only go on so long before a correction.

Inflation itself also has some real impacts. Just about all of these effects can be grouped under the heading of uncertainty (a four letter word on Wall Street). When employers, workers, borrowers, lenders, your grandma living on a fixed income, and heck just any old Joe down the street, can't get a good hold on what a dollar is going to be worth in real terms six months or a year from now, they are more likely to be cautions about making a loan, taking on a big new investment project, hiring new workers ect. Basically the same craziness that happens any time a dose of uncertainty comes to the market.

So what Big Ben is aiming to do is set an inflation target and keep inflation relatively stable and predictable. I don't think there's a big reason why the inflation target couldn't be 5% instead of 3% or 2%, but you have to figure if you loosen your target then when you start bumping up against 5% you have to tighten up again unless you raise your target further. In other words, to keep inflation predictable you have to draw the line in the sand somewhere.

Maybe I can think of a way to parlay these thoughts into a way to recover from my FICCle.

Any thoughts out there in the CAPS blogosphere?

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