Higher Inflation due to Fed Hikes
Allan Greenspan readily admits a lack of knowledge as to the reasons for the economies boom over the last few years. This lack of knowledge will continue until economist begin factoring the role higher interest rates play in increasing the inflation rate and change the seriously flawed fundamental premises proposed in Keynesian economics.
Basic Keynesian theory states a high demand of resources and labor causes a bidding war for these resources resulting in inflation. To fight inflation interest rates must be raised high enough to put enough companies out of business so that the demand for resources and labor is reduced. Of course, companies won't die overnight because of a .25% increase in interest rates. Instead they will raise prices to cover the extra cost incurred resulting in a situation where a large portion of the inflation rate is due primarily because of the measures taken to fight inflation. Our current situation marks a good example. The late 1970's and early 1980's serves as a better example.
The Chairman of the Federal Reserve Board at that time, Paul Volker, thoroughly embraced the tight money supply concept of reducing inflation. This lead to interest rates and unemployment rates near 20% and inflation rates in the mid teens. This situation remained until this policy nearly caused a complete collapse of the United States banking system. When the Fed was forced to dramatically increase the money supply in order to save the banking system the economy recovered almost immediately with precipitous drops in both the unemployment and inflation rates.
When examining Keynesian theory we also must examine the period of time of concept development. At that time governments were allowed to believe there were two distinct classes of people; one class whose contributions to society were so great their assets must be protected and one class whose assets could be sacrificed in order to protect the others. With this mind set if the demand for a resource that everyone needs (like oil) became great enough to threaten the living standards of the wealthy it was acceptable to freeze out the less wealthy.
In the nineteen seventies we had the opportunity lessen the burden of our dependence on oil. The natural market forces promoted companies willing to develop alternate energy sources, conservation techniques and efficient mechanical devices. Instead we allowed the fed to raise interest rates enough to eliminate these fledgling companies and stifle the innovations they promised. In those cases where an established company threaten to falter because of the same fed policies we would ignore the feds desire and step in to rescue that company. Thus as a society we failed to embrace the free market we claim to love and protected established businesses so that now in the 21st century we can relive the experiences of the 1970's.
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