[FoRK] What it means...
jbone at place.org
Sat Sep 26 09:37:57 PDT 2009
On Sep 26, 2009, at 11:02 AM, Jeff Bone wrote:
> The biggest problem the Fed faces is massive deflation. It's
> literally an existential risk for them. Under a deflationary
> scenario, all debt actually *shrinks* in value rather than grows.
I should clarify this: inflation (not deflation) causes the actual
(not notional) value of regular debt to shrink. The Fed, however, has
a different perspective on debt than the rest of us, as an essential
characteristic of its function. In general, the Fed is seeking to
preserve the value of its balance sheet and the usefulness of its
effectively-infinite credit rating; as such, deflation is a bigger
menace to it than steady, low-level inflation --- it is its
existential dilemma; deflation implies reduced demand, so even though
it has more effective notional buying power, the real value of that
buying power is reduced at some level of deflation. If you have any
objections to that simply note the influence of steady, low-level
inflation --- considered by central banks as a positive thing, of
course --- throughout the history of central banking in this country
or elsewhere. If significant deflation occurred, the Fed would
actually see a contraction of its own liquidity and hence the value of
its holdings, greatly impairing its ability to continue to operate.
Cf. Irving Fisher.
From a regular creditor's perspective, some level of debt-holding is
actually a deflationary hedge. From a banks perspective, and
particularly a central bank's perspective under fractional reserve
banking, an increased appetite for debt (as you would see under
significant deflation) outside the banking system and / or greater
savings rates vs. borrowing rates at the bank (also evident under
deflation) would be, beyond some level, bad for the bank --- and
catastrophic for a central bank.
Talking about things from the Fed's or any bank's perspective is
fraught with linguistic perils and clarity traps, as the perspective
is often quite the opposite of what one intuitively thinks something
means. My error for not making this clear...
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