Inflation is ultimately and always a monetary phenomenon. The Federal Reserve’s extraordinary actions during the recent crisis now require executing a difficult exit strategy without short-circuiting the recovery and most especially without letting inflation get out of control. Comments by Fed officials beginning with Chairman Ben Bernanke suggest they are committed to containing inflation and the Fed appears to have the tools to do so. But will they use those tools wisely? A specific, consistent thread in Bernanke’s comments suggest the Fed will yet let inflation get out of the bag despite the best intentions and tools.
The substance of the inflation threat is in two parts. The first is the trillion dollar mountain of bank excess reserves the Fed has created and that are now idling on the Fed’s balance sheet. If banks choose to begin tapping these reserves in large quantities, drawing them into the credit creation process, then the economy may get a welcome initial pop, soon to be followed by rapid resurgent inflation. The Fed has new tools, especially its ability to pay interest on excess reserves that should allow it to modulate the outflow of excess reserves.
Central to the Fed’s response in the recent crisis was the reduction of the Federal funds rate essentially to zero. At some point, the Fed must begin raising the funds rate toward a more normal, more neutral level. If the Fed is late in raising the funds rate, as it was late coming out of the last recession and as it was late in cutting the funds rate at the onset of the crisis, then even if it controls the outflow of excess reserves another spate of asset price bubbles is possible and unacceptably high inflation becomes likely.
The Fed has substantial credibility when it signals its intent to fight inflation. However, danger lurks in the Chairman’s words. The root of the danger is the pervasive belief that economic weakness in the form of substantial excess capacity and high unemployment will persistently dampen inflationary pressures. Whatever effects excess capacity has on inflation pressures in the short run, those pressures disappear before long (PDF is in draft form)
This recalls an earlier episode in the late 1960s and 1970s when economists believed they could buy a reduction in the unemployment rate at the cost of a modest increase in inflation. It turned out this fleeting bargain quickly produced stagflation – high unemployment and high inflation. The current thinking is just the converse – the belief that high unemployment buys low inflation. It does not work this way, either.
While Frank Sinatra wanted to wake up in a city that doesn’t sleep, today’s New Yorkers are looking to live in states where taxes aren’t so steep.
New York, whose state and local taxes are among the highest in the nation, is bleeding residents due in large part to the state’s extraordinarily high tax rate. According to a new study by The Empire Center for New York State Policy:
From 2000 to 2008, in both absolute and relative terms, New York experienced the nation’s largest loss of residents to other states—a net domestic migration outflow of over 1.5 million, or 8 percent of its population at the start of the decade.
Of those who left, 1.1 million were former residents of New York City. That means that the Big Apple lost one out of every seven city taxpayers.
And it’s not New York City’s giant sewer rats that are driving people away.
From the folks at the Empire State Center:
Click here to view the embedded video.What accounts for New York’s chronic inability to attract and retain more Americans than it loses every year? Any attempt to answer that question must begin with New York’s state and local tax burden, perennially ranked among the heaviest in the country. Taxes aside, likely explanations differ regionally. Downstate residents face high taxes and housing costs rated among the most “severely unaffordable” in the world. Land-use regulations in downstate New York also tend to inhibit growth. In upstate New York, housing is relatively inexpensive but even more heavily taxed, and new economic opportunities have been scarce.
While one-third of outbound New Yorkers seek sunnier clime and fresh-squeezed orange juice in Florida, that doesn’t mean that cold weather is the motivating factor behind the migration. The Empire Center notes that New Hampshire, Wisconsin and Minnesota have all seen increases in population, while New York’s has been shrinking.
The study’s prognosis? New York needs to change its ways:
This much is clear: with New York now facing the most serious fiscal and economic crisis in its modern history, government policies should be aimed at slowing down and ultimately reversing the state’s population drain.
One famous conservative has already pledged to leave. Last March, radio show host Rush Limbaugh, whose show is broadcast from Manhattan, proclaimed that he was “officially vacating New York” because he doesn’t want to foot the bill for a bloated government:
It’s punishing the achievers for the mistakes and the lack of discipline on the part of a bunch of corrupt politicians that have run that city and state into the ground for I don’t know how many years — and I, for one, am not going to take the blame for it.
Perhaps some tax cuts and fiscal responsibility are in order.