Industrial Insight

You should read this article… | January 25, 2011

January 24, 2011 Sixteen Cents: Pushing the Unstable Limits of Monetary Policy

John P. Hussman, Ph.D.

Because the size of the monetary base has become so extreme relative to historical norms, the likely price pressures in response to even modestly higher short-term interest rates are equally extreme. For example, given the present level of the monetary base, an exogenous increase in short-term Treasury yields to even 1% would imply a GDP deflator of about 1.59, which is about 42.9% higher than present levels. In order to counter such pressure, the Fed would have to contract the monetary base by about $600 billion, from the present level of about $2 trillion to a still bloated but less extreme $1.4 trillion.

A larger increase in Treasury bill yields to 4% would imply a GDP deflator of about 2.35, which is more than double the current price level. The implication is that any normalization of interest rates would need to be accompanied by a massive contraction of the Fed’s balance sheet in order to avoid inflation, otherwise the collapse in liquidity preference (resulting from the higher interest rates compared to zero interest on base money) would trigger a collapse in the purchasing power of cash.

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About author

I'm the executive vice president for a steel casting trade association, the Steel Founders' Society of America. I've got a crazy wife, five crazy children, three crazy people that married into the family, and two crazy fun little grandsons.







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