Economy Is Recovering Slower Than We Thought

[Matt Collins]

The Federal Reserve lowered its economic forecast as it moved to provide a controversial stimulus early this month and predicted unemployment could be higher than normal even when the economy is at full throttle again.

In the minutes of its Nov. 2-3 meeting released Tuesday, the central bank also shed light on why it decided in a 10-1 vote to buy $600 billion in Treasury bonds by June 30 in a bid to lower long-term interest rates. Reasons included fears the nation could fall into “persistent deflation” that would be “very costly.”


Read more: http://dailycaller.com/2010/11/24/fed-minutes-show-lower-recovery-expectations/#ixzz16DfKYF66

[eugenekop]

Deflation? But the Fed has printed tons of money, how can they expect persistent deflation? I don't understand it.

[hugolp]

Translation: We need to monetize more government debt, and we are going to say the economy is doing worse so we can justify the money printing.

[eugenekop]

No, really come on. How can they say there will be a persistent deflation when they constantly print money? Maybe they mean that there will be less credit available?

[Seraphim]

No, really come on. How can they say there will be a persistent deflation when they constantly print money? Maybe they mean that there will be less credit available?

Because the largest portion of the money supply is M3 and it IS deflating. M1 is base money. Base money has been RADICALLY expanded in the last decade.

When/if the demand for that base money rises, inflation will be torrential. Even as M3 contracts, stagflation is apparent to anyone paying attention.

[eugenekop]

M3 is the money in the bank deposits right? Why would that money deflate? With 0% interest rates I would expect less people to hold their money in the banks.

[Seraphim]

M3 is the money in the bank deposits right? Why would that money deflate? With 0% interest rates I would expect less people to hold their money in the banks.

M3 is M0, M1 and M2 combined PLUS bank loans that are tehn deposited. As people deleverage and pay off debts, M3 contracts.

[eugenekop]

Well, the following link: http://en.wikipedia.org/wiki/Money_supply
explains that M3 includes all the money deposited in the bank. As people pay their debts, they return give money to the banks, so M3 should grow, shouldn't it? I guess I understand this completely wrong.

[hugolp]

Well, the following link: http://en.wikipedia.org/wiki/Money_supply
explains that M3 includes all the money deposited in the bank. As people pay their debts, they return give money to the banks, so M3 should grow, shouldn't it? I guess I understand this completely wrong.

People is deleveralging, trying to pay the debts, therefore M3 goes down, which also has a deflationary effect. The problem is that the government and its central bank its doing the contrary. The central bank is increasing M0 like it has not done ever before, but that money is still in the banking reserves, therefore it has not leaked towards M1, M2 or M3. When it does it will create massive inflation. The discussion is if the Fed will be able to pull back and absorb all that money before is leaked. And the answer is a rotund NO. Its impossible for the Fed to do that, despite of what Bernanke or Krugman says.

EDIT: To understand why the Fed can not pull back one has to look to its balance sheet. Its really not that complicated. Brian had some great articles explaining it.

[eugenekop]

People is deleveralging, trying to pay the debts, therefore M3 goes down

Can you please explain this? If people pay their debts to the banks, they will deposit money in the banks, and since deposited money is included in the definition of M3, M3 should increase. What don't I understand here?

[hugolp]

Can you please explain this? If people pay their debts to the banks, they will deposit money in the banks, and since deposited money is included in the definition of M3, M3 should increase. What don't I understand here?

M3 includes loans longer than 1 year. When this loans diminish and the growth of M0 can not outdo it (it never does, because there is way more loans than M0) then M3 goes down.

If people deleverage, they are returning debt, meaning the amount of loans will go down, and thus M3 will go down.

[eugenekop]

Okay, I hope I understand. Now why does the Fed think that the decrease in M3 is a bad thing? Why do they fear it? If people pay their debts, we should be happy, shouldn't we?

[Seraphim]

Okay, I hope I understand. Now why does the Fed think that the decrease in M3 is a bad thing? Why do they fear it? If people pay their debts, we should be happy, shouldn't we?

Yep. The bankers aren't happy though. Deflation in this monetary system is akin to slaves becoming free(er).

[teacherone]

Can you please explain this? If people pay their debts to the banks, they will deposit money in the banks, and since deposited money is included in the definition of M3, M3 should increase. What don't I understand here?

when people pay off their debt to a bank the money that was created by that bank for the loan is destroyed (this is an accounting method...not literally).

the loaned money is now out of circulation, the bank keeps the interest and adds it to reserves or makes purchases or pays its employees.

[teacherone]

deflationists fear the "deadly deflationary cycle" where prices drop and people have the expectation that prices will drop further and therefore delay purchasing.

as the prices of products drop, companies' profit margins drop as well.

companies cut wages and wages begin to drop.

people don't have money to purchase and delay purchasing.

product prices drop.

ad infinitum.

[eugenekop]

Thank you for explaining this to me. A few points though.

1. Why did people suddenly started to pay their debts? What happened?
2. Why would prices drop if people started to pay more of their debts? Is that because people won't be spending their income money (and thus increasing the demand for goods)?
3. So what if people won't spend money. Why do the people in the Fed think that it is a bad thing? Is that because they believe that the economy has to be stimulated by spending? What do the Austrians think of it?
4. Isn't that a bit crazy that the government is worried that people pay their debts?