The Fed's economics is voodoo magic

By Sam Foster

I have a bachelors in economics, there's a reason my masters is in business.

Last month, the 1970's misery index hit an all time high thanks to record inflation. You won't read about this record inflation in the newsprint, but you can feel it when you fill up your gas tank. Today's inflation measure does not count food and gas, the old calculation did.

The point though, is that the only thing different from the stagflation in the 70's and now is the way inflation is calculated.

Now behold the Fed scratch their heads when they find out people are worried about inflation:

Last summer, concerns the U.S. could face a sustained period of falling prices prompted the Fed to step in with a second round of so-called quantitative easing to further support the economy. That program, known as QE2, is scheduled to end this month.

Recently, rising food and energy prices have fueled concerns about inflation. The Fed believes commodity price rises will be temporary and won't have a lasting impact on inflation.

Plosser said these swings in the public debate shows the need for clear communication from the Fed. He repeated his long-standing call for an explicit inflation target and a systematic exit plan from the Fed's extraordinarily easy monetary policy.

But, as I pointed out, the last time the nation faced similar economic malaise, the Fed did the opposite of an easy money policy:

When the misery index as but a mere 21.98 on the misery index was combated by then Paul Volker by raising interest rates…a lot:

The image of farmers blockading Washington D.C. with tractors is hard to imagine now, but those were tough times. The reason Volcker interest rates so aggressively was that inflation went wild in the late 1970s. For example, inflation hit 11.3% in 1979, 13.5% in 1980 and 10.3% in 1981 before Volcker’s harsh medicine began to kick in and inflation moderated to 6.2% in 1982.

As inflation ratcheted higher, so did home mortgages rates. Thirty-year fixed rate mortgages went up to nearly 13% in November 1979 and did not fall under 12% again until November 1985. The peak rate for mortgages was 18.45% in October 1981. 18.45%!

We anxiously await a conclusion, but only two potential outcomes are before us: one, doing the opposite of what we did last time works, in which case economics is proven voodoo magic or Q2E makes the Wiemar inflation of 1920's Germany look like a day in the park.

Who's for hoping on voodoo magic?

Via Memeorandum, image via BlogProf

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