Baker & Bernstein on The Incipient Inflation Freak-out

By Dean Baker and Jared Bernstein 

As predictable as August vacations, numerous economists and Federal Reserve watchers are arguing that the nation’s central bank must raise interest rates or risk an outbreak of spiraling inflation. Their campaign has heated up a bit in recent months, as one can cherry pick an indicator or two showing slightly faster growth in prices or wages. But an objective analysis of the recent data, along with longer-term wage trends, reveals that the stakes of premature tightening are unacceptably high. The vast majority of the population depends on their paychecks, not their stock portfolios. If the Fed were to slam on the breaks by raising interest rates as soon as workers started to see some long-awaited real wage gains, it would be acting to prevent most of the country from seeing improvements in living standards. To understand why continued support from the Fed is unlikely to be inflationary, consider three factors: the current state of key variables, the mechanics of inflationary pressures and the sharp rise in profits as a share of national income in recent years, along with its corollary, the fall in the compensation share.

Read rest here.

Kevin P. Gallagher On The Fed, Emerging Markets, & Role of The Dollar

By Kevin P. Gallagher

From Foreign Policy Magazine

Emerging-market and developing countries resented U.S. Federal Reserve Chair Ben Bernanke during his spell in office. In 2012, Brazilian President Dilma Rousseff scolded Bernanke and the Fed's loose monetary policy for creating a "tsunami" of financial flows to emerging markets that was appreciating currencies, causing asset bubbles, and exporting financial instability to the developing world. It may just turn out that they dislike Janet Yellen even more.Although it was Bernanke who started tapering the Fed's loose policy, Yellen will be the one to end quantitative easing and, eventually, raise short-term interest rates. And those could be an even bigger problem for emerging markets than the initial tsunami.Yellen's recent confirmation that quantitative easing (QE) will cease in October 2014 is the latest and firmest signal that U.S. monetary policy is reversing direction. The Fed began the year talking about the "tapering" of loose monetary policy, relaxing QE's bond-buying program and potentially raising interest rates. Now a concrete end to QE is on the horizon. The big question that emerging markets are now asking is how quickly and how suddenly interest rates will go up. Following the latest numbers that the United States' GDP grew by 4 percent during the second quarter, some monetary policy hawks are calling for interest-rate hikes soon to cool the economy. That's exactly what emerging markets are worried about....

Read rest here.

And for more on the role of the dollar in the world economy see here, here, and here

More on public debt and the rate of interest

An important point in the conservative (sound finance) argument against the increase in public debt, and the need for fiscal adjustment is that higher debt-to-GDP ratios would eventually lead to higher real interest rates.  In other words, the increase in debt would imply that economic agents would demand remuneration for holding government bonds.  The figure below shows the correlation between the change in public debt and the real rate of interest on bonds, between 1981 and 2009.

The result shows that an increase in the debt-to-GDP ratio of 1% leads to an increase of the real rate of interest on bonds os 0.07%.  In other words, the effect is in economic terms insignificant.  Much ado about nothing.

PS: As Nate Cline and Franklin Serrano kindly noticed, causality most likely runs from the rate of interest to debt.  Sure thing; the point here is just to note that even if the conservative point was correct, the actual effect would be insignificant.