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					Interest Rates
     and
   Inflation
       Dr. Dennis Foster
W.A. Franke College of Business

 Northern Arizona University
Wednesday, November 2, 2011
             An Economic Riddle
How can there be people with a wide variety
of skills out of work and looking for a job?


            How can there be machines, tools,
         equipment and factories that are idle?

How can there be financial resources
available to entrepreneurs in order to put
these people and these machines to work?
     -12.0%
              -10.0%
                       -8.0%
                               -6.0%
                                        -4.0%
                                                -2.0%
                                                                                           10.0%




                                                        0.0%
                                                               2.0%
                                                                      4.0%
                                                                             6.0%
                                                                                    8.0%
1990q1
1991q1




                               1991
1992q1
1993q1
1994q1
1995q1
1996q1
1997q1
1998q1
1999q1
2000q1
2001q1
2002q1
                                                                                                                 1990 to 2011




                                       2001




2003q1
2004q1
2005q1
2006q1
2007q1
                                                                                                   Real GDP - Quarterly Growth (Annual Rate)




2008q1
2009q1
2010q1
2011q1
Current state of the economy

      Dec. ‘82 - 10.8%                                  Oct. ‘09 - 10.1%




                    June ‘92 - 7.8%


                                      June ‘03 - 6.3%
         Recessions reduce Inflation
                                                            CPI - All Urban Consumers - 2000 to 2011

                            6
                                                                    (12 month percent change)
                                                                                                                       2008

                                              2001
                            5

                            4
Percentage (annual basis)




                            3

                            2

                            1

                            0

                            -1

                            -2

                            -3
                                 Jan-00


                                          Jan-01


                                                   Jan-02


                                                                Jan-03


                                                                         Jan-04


                                                                                  Jan-05


                                                                                           Jan-06


                                                                                                    Jan-07


                                                                                                             Jan-08


                                                                                                                      Jan-09


                                                                                                                               Jan-10


                                                                                                                                        Jan-11
Keynesian Economics 101
        What the Fed Does

• Buy U.S. Treasuries
• … bidding bond prices up
• … and bidding interest rates down
• … building up bank reserves
• … inducing lending, spending,
  production
  & employment
Old School Economics 101 :
Has policy become less effective?


              Effective Federal Funds Rate of Interest 1981 to 2011
20.00%

18.00%                 1982
16.00%

14.00%

12.00%
                                                                  1991
10.00%
                                                                                                   2001
 8.00%
                                                                                                                               2008
 6.00%

 4.00%

 2.00%

 0.00%
         Jan-81

                  Jan-83

                           Jan-85

                                    Jan-87

                                             Jan-89

                                                      Jan-91

                                                               Jan-93

                                                                        Jan-95

                                                                                 Jan-97

                                                                                          Jan-99

                                                                                                    Jan-01

                                                                                                             Jan-03

                                                                                                                      Jan-05

                                                                                                                               Jan-07

                                                                                                                                        Jan-09

                                                                                                                                                 Jan-11
           2
           4
                  6
                  8
                 10
                 12
                 14
                           16
                           18
                                                         20




           200
           400
                  600
                  800
                 1000
                 1200
                           1400
                           1600
                                                         1800




     0 0
Jan-90
Jan-90
Jan-91
Jan-92
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-96
Jan-97
Jan-98
Jan-98
Jan-00
Jan-99
Jan-00
Jan-02
Jan-01
Jan-02
Jan-04
Jan-03
Jan-06
Jan-04
Jan-05
Jan-08
Jan-06
                                                                          Bank Excess Reserves - 1990 to 2011
                                                                                                         2008


                                Sept. 2011 - $1.55 tr.




Jan-07
Jan-10
                                                                                                                An explosion in bank reserves




Jan-08
                                                          Billions of $




                 QE-I
                        QE-II
U.S. Treasuries:
$1.67 trillion


    MBS:
 $862 billion
  The Problem with Policy
• Eventually, banks will want to
  lend out these excess reserves.




• This can create an inflationary
  firestorm.
 The Problem with Policy
• The FED will have two choices:
  • Continue policy  hyperinflation
  • Halt policy  recession




  • Or . . . Wage/Price controls?
Rethinking Policy:
The Austrian School of Thought

• Recessions are the solution,
  not the problem!
• Keynesian policy -  interest to spending.
  • Leads to misallocation of resources.
  • Leads to an unsustainable boom.
  • Leads to eventual conflict (C vs. I).

• What should we do? Wait!!
                                         Real GDP - Quarterly Growth (Annual Rate)
                                                       1990 to 2011
10.0%
 8.0%
 6.0%
 4.0%
 2.0%
 0.0%
 -2.0%
 -4.0%                        GDP (2011) = $18.3 tr. vs. $13.3 tr.
 -6.0%
 -8.0%                              1990 - 2011 net gain = $34.6 tr.
-10.0%
-12.0%
         1990q1
                  1991q1
                           1992q1
                                    1993q1
                                             1994q1
                                                      1995q1
                                                               1996q1
                                                                        1997q1
                                                                                 1998q1
                                                                                          1999q1
                                                                                                   2000q1
                                                                                                            2001q1
                                                                                                                     2002q1
                                                                                                                              2003q1
                                                                                                                                       2004q1
                                                                                                                                                2005q1
                                                                                                                                                         2006q1
                                                                                                                                                                  2007q1
                                                                                                                                                                           2008q1
                                                                                                                                                                                    2009q1
                                                                                                                                                                                             2010q1
                                                                                                                                                                                                      2011q1
Interest Rates
     and
   Inflation
       Dr. Dennis Foster
W.A. Franke College of Business

 Northern Arizona University
Wednesday, November 2, 2011
The W.A. Franke College of Business
    Northern Arizona University
           Spring 2012




               ECO 481:
         Public Choice Theory
                          Tue/Thur 12:45 pm - 2:00 pm




                                           Dr. Dennis Foster
                                                  FCB #308

				
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