Harvard Economist Martin Feldstein – Conservative – Embarrasses Himself With Lack of Understanding of Basic Economics

Harvard Can’t Be Too Happy Either

To the horror of conservative economists, those who put their own personal beliefs in front of rational economic analysis, the inflation they predicted from the Obama economic policy of running large budget deficits to stimulate the economy hasn’t happened.  Even worse, the big rise in interest rates that they predicted haven’t occurred either.  In short, the economic analysis done by conservative economists has been totally, completely and utterly wrong.

Now there is nothing wrong with being wrong, The Dismal Political Economist has great experience in that area.  But being wrong is a learning moment, a teaching moment.  In fact, it is a stronger teaching moment than being right because it forces one to examine just where one went wrong.  Unless of course one is a conservative, in that case one is never wrong, reality is at fault.

A great example of all of this is the Harvard economist and former Reagan adviser Margin Feldstein.  Writing in the Wall Street Journal Mr. Feldstein is horrified, horrified that this might be the result of current Federal Reserve policy.

For now, the banks are content to leave their excess reserves at the Fed in exchange for a low rate of interest. But the day will come when aggregate demand is increasing, companies want to borrow, and the banks are willing to lend aggressively.

Now an intelligent, unbiased economist would say this is great, this is exactly what everyone wants to happen.  This means the economy will be growing.  But to Mr. Feldstein, the horror is that inflation will result (even though it won’t).

When the increase in money starts to cause a rapid increase in prices, the Fed will need to limit the banks' credit creation by raising the interest rate it pays for banks to keep their reserves at the central bank.

When business is investing and expanding in an economy with idle resources, ie the United States now, inflation doesn’t result, growth does.  Only after the economy reaches full employment and demand by business and consumers continues does inflation occur.  Really, this is the case, it’s in all the texts and has occurred so many times in the past that it is no longer even subject to controversy.

But Mr. Feldstein and conservatives cannot stand prosperity if it comes under Democratic rule.  So they rue the Federal Reserve policy that just might create prosperity.

The Fed's new approach appears to raise the inflation threshold above 2%. Moreover, at his news conference after the December FOMC meeting, Mr. Bernanke made it clear that there is both flexibility and ambiguity in how the central bank will apply this new approach. It won't judge labor-market conditions by the unemployment rate alone, and its expectation of inflation will reflect a variety of indicators.

Mr. Feldstein’s complaint with this utterly rational approach.  It confuses people.

It will be difficult for the public to understand what the Fed is trying to do, and even technical monetary experts will be unable to anticipate when and by how much the Fed will change the federal-funds rate. The outlook for monetary policy is further confused by the Fed's comment that the new unemployment and inflation guideposts apply only to the fed-funds rate and not to the Fed's purchases of Treasury bonds and mortgage-backed securities.

Actually the only people confused are people like Mr. Feldstein, who cannot understand basic monetary policy.  But here is the real reason conservative are opposed to the Fed policy.  By keeping interest rates low it allows the government to borrow less expensively and stimulate the economy.

The final problem with the Fed's unconventional policy is perhaps the most obvious. By keeping long-term interest rates low, it removes pressure on Congress and the Obama administration to deal with budget deficits.

The deficit has increased to 7% of gross domestic product this year from 1.5% in 2007. The ratio of debt to GDP has doubled in that time to 73%. Even if the president's original proposed budget was enacted and accomplished all the deficit reduction that the administration claims, the debt-to-GDP ratio would still be above 70% in 2022 and would be expected to rise after that. The Fed, in short, has killed the bond vigilantes before they could have forced Congress to act.

So what we have here is the ravings of a man who doesn’t understand basic economics, that expansionary monetary policy can create growth, increase tax revenues, reduce the need for government spending and reduce the budget deficit, which he says is his goal in the first place.   How can he be teaching at Harvard?  How could he even be teaching at East Podunk Community College?