Scott Sumner complains that liberals are suddenly changing their tune on monetary policy. Perhaps, but this is the time to make love not distracting infighting.

I don’t have to remind Scott that he and I live a life that is virtually recession proof. Millions of Americans do not. This isn’t the time to be alienating anyone who might help our cause.

And just for the record, since I didn’t make the initial list


100 Basis Points

I am off to the state legislature this morning so no faux statement. However, I still maintain that there is no tightrope. The Fed has to be focused on preventing the liquidity trap and jump starting credit markets as soon as possible.

Moreover, M1 is flat and credit contracting. This should be leading to an effective decline in the money supply. Ultimately that is deflationary.

The statement should have some nod to commodity prices and risks but the predominate concern is stability in financial markets and the outlook for growth. In short, look out below, we are heading for 1% as fast as is prudent.


and of course

FRIDAY, MARCH 14, 2008

Liquidity Trap, Delfation, ZLB

Lots of people have said to me both on and off line that we don’t have to worry about the Japan Scenario because we have a solid inflation buffer in the US.

While the inflation buffer gives us more room in a sense, it is important to remember that it is not deflation per se that causes a liquidity trap. It is that the equilibrium interest rate is below zero.

It is possible that the equilibrium risk free interest rate is a real negative 3% in this crisis, which implies that we still won’t be able to get there with 2.7% inflation.

Exploding risk premiums could drive the equilibrium real rate that low because what matters is credit availability to firms and consumers.
So we are not in a position were we can ignore the liquidity trap possibility. On top of that is the issue that there are increasing deflation pressures in the decline collateral values, falling consumption and the potential for dramatically slower global growth. While ultimately they might not override inflationary effects of recent Fed policy, they are not to be ignored.

In short deflation cannot be ruled out and the liquidity trap remains a threat even in a moderately inflationary environment.


I think I have as much standing as Scott to grumble about Johnny-come-latelies but this simply isn’t the time.