Protecting the Dollar
Posted on May 27, 2008
Brian Wesbury, a Chicago economist, has a great op-ed in The Wall Street Journal today, entitled “Déjà vu: The Fed’s Interest Rate Dilemma,” that is the best explanation I have seen about what is happening to the dollar and how to fix it.
Wesbury’s theory is that easy monetary policy has devalued the dollar and made bad situations in the energy and food sectors much worse. “Since 2001, and especially since September 2007 — when the Fed starting cutting rates in response to credit market issues — excessively easy monetary policy has driven oil and other commodity prices through the roof.”
Wesbury goes on to say: “The good news is we’ve been here before, and we know — well, at least 1980s Fed Chairman Paul Volcker knows — how to get out of this mess. Loose money in the 1960s and 1970s drove up the price of everything. A barrel of oil, which sold for $2.92 in 1965, rose to $40 in 1980. Most people believed that rising commodity prices indicated that the world was running out of resources … In 1980, then-Fed Chairman Volcker lifted the Fed funds rate significantly above GDP growth and held it there long enough to end inflation. This policy instigated a steep decline in oil prices, and drove a stake through the heart of stagflation.”
I am not an economist, and I know some economists will argue that core inflation is not a problem. I guess I don’t know what core inflation is, because it seems to me that when gas prices and food prices rise steeply, that is inflation.
And the way to handle this situation, according to Wesbury, is to align the federal funds rate with nominal GDP growth. That calls for an increase in interest rates, not a further cut.
Sometimes the right solution is counterintuitive. Sometimes, cutting interest rates makes a slowing economy worse, especially when the dollar’s value is under assault. If you don’t believe me, look what happened to Japan over the last decade.
Sometimes, going on a government spending-spree makes the situation worse. The Keynesian model tactic of priming the pump used to be the way the government handled every economic problem, but most economists have discarded that theory. Sharply increasing the deficit will only make the situation worse.
Tax-hungry Democrats will argue that we should raise taxes, but as Wesbury points out, “tax-rate reductions and interest-rate hikes cured the world of its ills in the early 1980s. They can do so again.”
Amen to that, brother.