In recent economic news, Minneapolis Fed President Narayana Kocherlakota changed his stance regarding our current extremely low interest rates .In his speech, Kocherlakota advocated keeping interest rates near zero until the unemployment rate drops below 5.5%, as long as inflation stays below 2.25%. This stance is a reversal from his previous stance that we would have to increase interest rates to raise borrowing costs and guard against high inflation (He is still clearly concerned about inflation, given his 2.25% stipulation).
The September 28th WSJ article by John Hilsenrath “Another Reason Kocherlakota Changed His Mind” talks about one of the inspirations behind his change of heart. MIT Professor Ivan Werning presented the idea that central banks should promise low interest rates during hard economic times, but that this policy would not necessarily lead to high inflation. As Werning says, “The whole point is to stimulate a consumption boom.”
Now, will it work? Some economists don’t care. Some, like Paul Krugman, believe that inflation will actually help recovery by encouraged spending. For Kocherlakota, however, keeping at least reasonably low levels of inflation is important. The low interest rates should encourage investment and hiring due to increased lending. Over time, this should reduce the unemployment rate, hopefully substantially. If this policy is also successful in encouraging consumption in a major way, overall economic recovery will be bolstered greatly.
Whether or not this can occur without inflation remains to be seen. “Easy money” policies are usually associated with relatively high inflation. Kocherlakota is hoping that this is not necessarily the case.