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Charles Evans, Fed President: Why The Economy Is In A 'Trap'

Fed

The Huffington Post   First Posted: 10/18/10 10:45 AM ET Updated: 05/25/11 07:05 PM ET

Higher prices, one top Federal Reserve official believes, could lead us out of the economic slump.

The current problem, Chicago Fed President Charles Evans said in a speech Saturday, is that even though interest rates are near rock-bottom, people are tending to save money rather than spend it. The situation, called a "liquidity trap," means the economy resists the Fed's attempts to kick-start it: Even when money is cheap, people don't use it. But Evans proposed a solution.

In addition to a new round of quantitative easing, an asset-purchase strategy that would boost inflation and lower interest rates as more money enters the economy, the Fed could pursue "price-level targeting." Rather than aim for a specific level of inflation, a price-targeting program would, as the name suggests, aim for a specific level of prices and use any inflationary means necessary to get there.

In general, low interest rates have encouraged banks and other companies to borrow cheap money without spending it. U.S. corporations saw profits rise in the second quarter, despite declines in revenue, because many have been hoarding their cash -- a tendency that the New York Times noted won't do much good for the economy, since companies won't, for example, use that money to create jobs.

Promoting inflation via price-level targeting won't be popular, Evans predicted. "Central bankers and the public generally loathe the idea that even a temporarily higher inflation rate could be beneficial or be consistent with price stability over the longer term," he said, adding later that "Most critiques I have heard of this type of policy tool involve the risk of runaway inflation expectations or the loss of hard-earned credibility." Still, he said, despite the risks, the policy is at least worth considering.

Other Federal Reserve officials might not share Evans' views. St. Louis Fed president James Bullard told the Financial Times he was "sympathetic" to price-level targeting but added, "I don't think we're going to go in that direction any time soon."

Bank profits in recent months have also been boosted by the low interest rates, as HuffPost's Shahien Nasiripour reported in August. But again, lending dropped significantly, as confidence has remained low.

The current low rates have hurt savers, whose certificates of deposit and money market accounts are earning very little interest.

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