As economic growth slows in the US and Europe, and fears of another recession increase, criticism of the Fed's policies has intensified. In his latest Economic Outlook, AEI economist John Makin warns us of Three Dangerous Myths about Monetary Policy which, if acted upon, could disrupt world markets:
The Fed's effort to stimulate the nation's economy by keeping interest rates low will trigger higher inflation or even hyperinflation: The latest data show the three-month annualized pace has fallen from 3% during the second quarter to 2% in the third quarter. Historically, reducing the money supply during a crisis intensifies problems.
A gold standard would be the best policy to ensure price stability: When the US had the ability to convert the dollar into gold, increased demand for the dollar allowed the US borrow more easily, resulting in higher inflation in the US and an eventual breakdown of the gold exchange standard.
The Fed is enabling expansionary fiscal policy and larger budget deficits by printing money: After a financial crisis, the path of inflation is highly unstable. If a fiscal stimulus fails, the demand for cash rises as investors move to less risky assets. If the Fed withdraws liquidity in this scenario, excess demand for cash can cause deflation to emerge rapidly, and the economy may become stuck in a deflationary liquidity trap.
John Makin writes AEI's monthly Economic Outlook. A former consultant to the US Treasury Department, the Congressional Budget Office, and the International Monetary Fund, Makin is available for media inquiries, and can be reached at jmakin@aei.org or through his assistant, daniel.hanson@aei.org (202.862.5883). AEI's in-house ReadyCam TV studio may be booked by calling VideoLink at 617.340.4300. For radio interviews, please e-mail margaret.mccarthy@aei.org.
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