Energy, Inflation, and Recession

The Markit/JMMA Japan Manufacturing PMI™ shows Downturn of manufacturing sector accelerated during December. Key points: Output and new orders register sharpest contractions for 20 months Employment, purchasing and stocks all continue to be cut Output charges lowered further as input prices remain unchanged

EARLY this week, my colleague questioned the wisdom of encouraging central banks to raise inflation expectations. Having written (once or twice) on why doing so is in fact a good idea, I thought I'd respond to a few points.

This morning Markit released Eurozone, France, and Germany preliminary PMI reports. All show further deterioration. Germany Markit Flash Germany PMI® shows Manufacturing weakness behind moderate drop in German private sector output during October. Summary

You don't go to Inflation Report press conferences nowadays to get cheered up. The "news", if we can call it that, is that the Bank's Monetary Policy Committee (MPC) now thinks inflation will be significantly higher than they previously thought, not just in 2011 but in 2012. Indeed, if reality - by some freakish accident - follows the path suggested by the new forecast, the target measure of inflation will still be within shouting distance of 3% a year from now.

The President's new initiative on increasing energy independence inspired much commentary on how much it was aspirational, rather than realistic; see for instance this extensive NYT article. In this post, I want to consider whether reduced dependence on imported energy is a worthwhile objective. Oil Price Shocks: How Important in the Past? What are the macroeconomic consequences of oil shocks.

SCOTT SUMNER has been a frequent subject of this blog over the past year or so. Mr Sumner, an economist at Bentley University, came to prominence during the recession and recovery for observing that the Fed was doing far too little to support the economy, and (perhaps more important) that it had helped precipitate the deep recession by doing too little in 2008, during which time nominal GDP was falling sharply.

Reader RG sent me a link to a year-old paper from the New York Fed (PDF) which pretty clearly lays out the policy rationale for paying interest on excess bank reserves, and in the course of doing so helps explain why it’s a mistake: