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Reply #24


Response to Demeter (Original post)

Sat Apr 28, 2012, 08:18 AM

24. The 2% Catastrophe: How One Number Explains the Miserable Economy

http://www.theatlantic.com/business/archive/2012/04/the-2-catastrophe-how-one-number-explains-the-miserable-economy/256382/

The Federal Reserve balance sheet contains roughly $2.5 trillion worth of Treasuries, Fannie Mae bonds and mortgage-backed securities. But there is one asset the Fed considers invaluable. Credibility.

Most people think the central bank's job is manipulating interest rates, but the Fed is really in the business of making and keeping promises about the economy. Lately the Fed is obsessed with a narrow construction of credibility that is holding back the entire country.

The Fed has fetishized two-percent inflation.

WHO'S AFRAID OF 3%?

The Fed makes a very simple promise: It promises to keep inflation at a certain level every year. That level has changed over the past 30 years, but it's currently around 2% a year. If the economy is running too hot, the Fed raises interest rates. If it's running cold, it lowers rates.

For 30 years, this worked spectacularly. Recessions were rare and shallow. Inflation was low. Then 2008 happened. Even zero interest rates weren't enough to revive the collapsing economy. That's still mostly true now. In fact, our disappointing recovery is in large part the result of a central bank target that no longer serves the economy.

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