Saturday, April 23, 2011

Fed Caught Between Stopping Inflation And Allowing US Default

From "Central Bank Independence and Sovereign Default" by Narayana Kocherlakota, President, Federal Reserve Bank of Minneapolis at Wharton Conference, Philadelphia, Pennsylvania, April 1, 2011:
Let me wrap up. I’ve argued that even if the fiscal authority borrows exclusively in its country’s own currency, the central bank can have a large amount of control over the price level. But the central bank can only achieve that control if it is willing to commit to letting the fiscal authority default. Such a commitment may expose the country to risks of short-term and medium-term output losses. How this trade-off should best be resolved awaits future research. But I suspect that it may be optimal for central banks to guarantee fiscal authority debts in some situations. If so, we again have to think of price level determination as something that is done jointly by the fiscal authority and the central bank — just as Sargent and Wallace taught us 30 years ago.
Read the speech here.

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