Making an Accurate Prediction About the Economy

When one understands what really causes inflation, and what effect inflation has on an economy, making accurate predictions about how the economy is going to do going forward becomes much easier. That is why today most economists predictions about the economy are worthless. Most economists today do not understand what inflation really is, so they have little or no hope of making accurate economic predictions consistently.

I wrote the following last October about the economy:


As is starting to become evident, our economy is slowing down rather dramatically. The Federal Reserve will, of course, blame higher energy prices and the hurricanes as the causes. Complete and utter nonsense.

It is the Federal Reserve’s actions over the past year and a half which are now causing the slowdown. The Federal Reserve has nearly Quadrupled the fed funds rate over this short time frame, which is the overwhelming factor in the economy slowing. The main questions going forward are how much will the economy slow and will the Federal Reserve continue on until it causes yet another recession?

The stated purposes of the Federal Reserve for raising the fed funds rate so dramatically are price stability and to contain inflation. The facts clearly show that the Federal Reserve’s actions and its stated reasons for those actions are at cross purposes. In order to show this let’s look at two economies.

Japan for well over a decade has had nominal interest rates. Rates that the Federal Reserve would call “accommodative”. According to the logic the Federal Reserve is following today, Japan must have had high inflation and no price stability. In fact, just the opposite is the case as Japan has had no inflation and relative price stability.

The German economy, especially prior to the formation of the European Union, has had high interest rates. According to the logic the Federal Reserve is following today, Germany must have no inflation and price stability. In fact, Germany, despite the high rates, has been struggling with persistent inflation above what it wants.

Both economies have been struggling with low growth and high unemployment.

The reason why both Japan and Germany have had economic problems is simple. Both are trying to control interest rates instead of letting the market do so. By setting interest rates, and not letting the market do so, both are interfering with the natural growth rate of money.

In Japan’s case, by keeping rates too low, all of the trillions of yen in financial institutions are earning little or no interest, causing very little natural money supply growth.

In Germany’s case, the above market rates are causing all the marks in financial institutions to earn more interest than they should, causing natural money growth to be higher than it should be, causing the nagging inflation that is higher than Germany wants.

In our economy over the last year and a half, we have seen both sides of the coin. The Federal Reserve had interest rates too low, causing money growth to be low as well as inflation and job growth to be low. Since, the Federal Reserve has raised rates, to the point where they are now too high, which will cause persistent and nagging inflation to be above what the Federal Reserve would like, and slowing growth and, unfortunately and almost certainly, causing job growth to disappear.

Today the Federal Reserve has trapped itself. It raised short term rates to keep inflation in check, but by raising rates above where they belong the Federal Reserve is also causing natural money growth to be higher than it should be. Once again we see a case where the Federal Reserve is fighting itself. Going forward, as inflation numbers stay persistently above what the Federal Reserve wants, the Federal Reserve will continue to raise rates, eventually choking off all economic growth.

The facts are clear. If the Federal Reserve really wants to keep inflation low, it should LOWER the fed funds rate today. A year and half ago I wrote that in order for the economy to have better economic and job growth the Federal Reserve needed to RAISE the fed funds rate, not lower it to zero (as the Fed said it would do at the time and almost all economists at the time said it should do). Today, in order to accomplish its stated goals of price stability and no inflation, the Federal Reserve needs to LOWER short term rates to where they would naturally go if the Federal Reserve was not trying to manipulate them.

As the facts turned out I was right a year and half ago, as the Federal Reserve raised short term rates and economic and job growth picked up smartly. Unfortunately, and it saddens me greatly, but I will be shown to be right again.


- October 11, 2005

Raising Interest Rates to Stop or Control Inflation Makes NO Sense in the Real World

The idea that raising interest rates will stop or prevent inflation is pure folly. Anyone who actually believes that inflation can be prevented or slowed by raising interest rates would be very hard pressed to prove that in the Real World. As the Federal Reserve kept raising interest rates to "stop or prevent inflation", I wrote the following:



The Federal Reserve is raising interest rates to slow or stop inflation. According to the Federal Reserve’s logic, economies that have the highest interest rates MUST have the lowest inflation rates. Conversely, economies with the lowest interest rates, MUST have the highest inflation rates.

Japan, for well over a decade, has had the lowest interest rates on the planet, almost non-existent interest rates at times. Therefore, according to the Federal Reserve’s brilliant logic, Japan MUST have had, and still have, the highest inflation rates in the world. Do they?

Mexico and Brazil, over the last decade, have had some of the highest interest rates in the world. So, according to the Federal Reserve’s brilliant logic, Mexico and Brazil MUST have had, and still have, the lowest inflation rates in the world. Do they?

- March 22, 2005

High Oil Prices Will Not Cause Inflation or a Recession

When oil prices really started to rise a few years ago many economists predicted that the higher oil prices would translate into higher inflation levels and slower economic growth, with more than a few predicting that high oil prices would cause a recession. In response to such ignorant thinking, I wrote the following:


High Oil Prices and Economic Growth

No matter how high oil prices go, when we go to the pump or use oil in any other way, a business transaction is taking place. Economic activity is continuing. Money may be diverted from other transactions to pay for the higher oil prices, but economic activity does not stop.

Economic activity stops when the amount of money in circulation changes, specifically, when the growth rate of money in circulation slows or stops dramatically. Higher oil prices do not effect the amount of money in circulation, or the growth rate of money in circulation. So higher oil prices will not cause economic activity to stop. Higher oil prices, in and of itself, will not cause a recession.

In the 1970’s, the Federal Reserve, due to higher oil prices, inflated the amount of money in circulation. The Fed did this because the leaders at that time believed that in order to pay the higher oil prices there had to be more money in circulation in the economy. All this mistaken logic did was to cause inflation. When the inflation came the Fed stopped inflating the money supply and a recession followed. It was the Federal Reserve’s dramatic slowing of money growth which caused the recession.

No matter how high oil prices go, inflation will not occur unless the Federal Reserve inflates the amount of money in circulation. The higher inflation of the 1970’s was not caused directly by higher oil prices, but by the mistaken policy decisions made by the Federal Reserve at that time regarding higher oil prices.

- October 5, 2004