Monday, April 2, 2012

Feldstein on inflation risk

Great article by Harvard's Marty Feldstein on the pressures facing the Fed to stimulate the economy while keeping inflation in check.  The Fed has flooded the banking system with liquidity.  So far banks have sat on their excess reserves and received 0.25% interest from the Fed.  But at some point, Feldstein argues, banks will start loaning these funds out to households and businesses.  Even though unemployment remains over 8 percent, Feldstein is concerned about capacity constraints. 

Half of the unemployed have been out of work for a year or more; there is a significant risk that the long-term unemployed will not be reabsorbed into the labor market very quickly.  Feldstein's fear: the unemployment rate gets stuck at 7.5 percent, causing Congress to press the Fed to keep the stimulus going at a time when all the excess money in circulation starts leading to higher prices. The Fed has never injected this much liquidity into financial markets before; will the Fed know when and how to remove the excess liquidity?

1 comment:

  1. That hits the nail on the head. Right now, there is not inflation, but if the FED misjudges when to hoover the excess reserves back, things down the road could get ugly fast.