price stability

Odd Couple (of Goals)

Surveys indicate the public’s trust in the Federal Reserve has been declining over time. We totally understand this result.

The Federal Reserve, like other central banks around the world, plays a significant role in setting monetary policy. It operates under mandates written in law to promote full employment and price stability. Presumably, most people would be in favor of these worthy objects.

In practice, however, it seeks to raise the cost of living by 2% every year: that’s the actual effect of the goal we typically hear about, to hit an “inflation target of 2%.” That term is a less clear way of saying “raise the cost of living.” How many of us actually want that?

Now add in Federal Reserve policy on interest rates: keep them near zero for the next few years. So if the cost of living is rising and we earn next to nothing on our savings, then we are really going backward in purchasing power. A dollar of savings today plus zero interest for the next year and we will be short by 2 cents to buy the same amount of goods a year from now. That is a risk to our financial position.

This really is an odd couple of goals. It is rough on savers and people on fixed incomes.

The Federal Reserve has its rationale for all this, of course. It believes that a little inflation is good for the economy and that we are prone to have our spending manipulated by its policies for the short-term benefit of the economy. A better economy means more jobs, which is generally good for each of us.

We have our doubts about the logic. Fortunately, we can try to invest to take advantage of the opportunities these policies present. If we are willing to live with fluctuations in value, we may still be able to earn returns.

We believe it was simpler when savings had positive returns, but we are here to make the most of it.

Clients, if you would like to talk about the risks and rewards of investing and saving, please email us or call.

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A is A

© Can Stock Photo / hurricanehank

At the height of ancient Greek civilization, the philosopher Aristotle taught the Law of Identity. A is A. Everything has a single identity, not two or more, and two different things do not share the same identity. A is A. A dog is not a cat; an orange is not an orangutan, an olive is an olive.

One wonders what has been lost through the centuries, when considering Federal Reserve Bank policy. The Fed, as it is known, is charged with a dual mandate. It is supposed to promote maximum employment and stable prices.

If Aristotle were alive today, he might teach that stable prices are stable prices. This would be in accordance with the Law of Identity. A thing is what it is. Yet the Fed has adopted a 2% inflation target, supposedly in accordance with its mandate of price stability1.

At 2% inflation, a dollar today buys only 98 cents worth of goods next year and about 96 cents the year after. Prices would double every 35 years or so, under this inflation target. Over the course of a century, a dollar would shrink to about 12 cents in purchasing power. In what sense is this ‘price stability?’ It violates the simple precept that Aristotle taught 2,300 years ago.

One error some people make is presuming the things we can measure are important, and the things we cannot measure are unimportant. Higher dollar volumes of activity are presumed to be good. So when productivity or technological improvements reduce prices of things we purchase and use, we are obviously better off—but conventional economic statistics may indicate otherwise.

There are ramifications for us as investors. The threats to our prosperity from inflation may be discounted by the Federal Reserve. The advantages of technological progress are understated. We think this means we need to be more sensitive to the damage that future inflation might do to our wealth, and the opportunities presented by technological progress.

Clients, if you have any questions about this or any other pertinent topic, please email us or call.

1Board of Governors of the Federal Reserve System, https://www.federalreserve.gov/faqs/economy_14400.htm

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

This is a hypothetical example and is not representative of any specific investment. Your results may vary.