Federal Reserve officials have repeatedly expressed dissatisfaction with progress in reducing consumer price inflation. It’s understandable given that the Fed has undertaken the largest series of rate hikes in four decades, yet consumer price inflation remains recalcitrant.
The Fed needed to raise rates. Its rate target has been below the rate of inflation for a decade and a half, and that has inflicted deep economic damage. Debt has soared – just what you would expect from making it better than free – and created inflation, yet economists are fretting about an imminent recession. Not without cause … the treasury yield curve has been inverted for the better part of a year … deeply and broadly – as we have pointed out a number of times.
What’s more, a sinking dollar and rising asset prices – stocks, bonds, commodities – make clear that even with nearly five percent of rate hikes under its belt, inflation is still entering the pipeline.
But now rates are high enough. Fed funds is higher than most of the Treasury yield curve. Yet inflation remains stubborn.
What could be wrong?
The answer is strikingly simple. In the spirit of a picture is worth a thousand words:
The Fed has been overly focused on the Fed funds target, and negligent on the balance sheet. What you see on the right is just so far out of line with the rest of history it’s absurd. What’s more, a lot of what’s on the balance sheet never had any business being there in the first place. Trillions worth of mortgages. The Fed exceeded its remit by encroaching into fiscal policy. The only assets that should be on its balance sheet are are purely monetary ones, particularly Treasuries and gold.
But size matters. Expanding the balance sheet by several trillion dollars and then trimming it by a few hundred billion is leaving a massive amount of high powered money in the system.
And another policy variable that has received almost no media attention – but which desperately cries out for it – is bank reserve requirements. The Fed cut them to zero on March 26, 2020 … and then just left them there.
“As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.”
This not only opens the throttle wide on the money multiplier – the factor by which base money gets multiplied in the banking system – but also courts bank insolvency.
Just a coincidence, I’m sure.
3 thoughts on “Enough With The Rate Hikes”
from jeff snider
We’ve rarely EVER seen banks reduce bank credit as much as they did in the second half of March. De-risking not seen in over a generation. We know by markets this was an epic shock. More confirmation that it was…and that is going to get much worse.
Snider is suffering from top tick base effect. Let’s put it in perspective.
Bank Credit 20230414
Zooming in on the last ten years, we see that the recent contraction pales in comparison to the 2020 expansion. We can also see that even after the pullback, it’s expanded by over 70% – about 7% a year – far in excess of GDP.
Zooming in on just the past year, we can see Snider’s big scary contraction hasn’t even reversed the expansion of the past twelve months … during which the Fed has ostensibly been on the inflation fighting warpath. Bank credit is only back to about where it was last August, when the world wasn’t coming to an end, and there’s still nearly 3% more bank credit now than there was at this time last year.
Markets say money is still easy; that there’s an excess of supply over demand. The dollar is depreciating against stocks, bonds, foreign currencies, gold, copper, oil, goods, services, labor …
… but call me an optimist … I still think there could be a nice deflationary breeze ahead. There may be hope for the dollar yet.