The Fed Game: Anything More Than a Distraction?

By at 12 July, 2019, 8:30 am

by Raymond J. Keating-

Federal Reserve Chairman Jerome Powell testified before Congress this week. The media and market attention was outsized relative to the Fed’s impact on the economy these days.

First, the good news is that the latest Consumer Price Index data reported on July 11 showed low inflation in June (+0.1 percent), and a mere 1.6 percent over the past year. Low inflation is always a plus for the economy.

However, it’s hard to detect the Fed’s hand here, given that the Fed vastly expanded the monetary base starting in the summer of 2008 through the fall of 2015. Interestingly, inflation remained relatively calm, while the Fed’s hope to stimulate the economy amounted to nothing. Instead, the main effect of the Fed’s unprecedented loose money was unprecedented growth in bank reserves, along with creating added uncertainty for investors and entrepreneurs. In effect, the market saved the economy from the consequences of irresponsible monetary policy.

Subsequently, monetary policy matters meandered for two years. Then, starting in the fall 2017, the Fed has been methodically reining in the monetary base. (See Charts 1 and 2)

Chart 1: Monetary Base, January 1959 to June 2019

Source: Federal Reserve Bank of St. Louis, FRED


Chart 2: Monetary Base, January 2016 to June 2019

Source: Federal Reserve Bank of St. Louis, FRED

So, what lies ahead on the monetary front? Well, let’s be clear that any push to devalue the U.S. dollar is counterproductive if one is looking to boost investment and growth. As George Melloan noted in a recent and important Wall Street Journal piece:

And then there is the argument by trade warriors that a country can gain competitive advantage in international trade by devaluing its currency, or in other words devalue its way to prosperity. That myth has endured for decades in Britain, with untoward consequences.

A weak currency may increase cash flow when a corporation converts its earnings abroad in stronger currencies back into its own money. But while that might make an income statement look good for a while, it doesn’t translate into competitive advantage for the nation as a whole, or even boost income statements for the long haul. That’s because the weak currency raises the cost of inputs in nominal terms. In other words, fiddling with the currency doesn’t alter the terms of trade in any real sense.

In the end, monetary policy should be focused on price stability. To the extent that the Fed is getting back to that purpose – given the reining in of the monetary base over the past year-and-two-thirds – that’s a developing policy positive for the economy.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

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