The Fed’s Wildly Disproportionate Response to Economic Troubles

By at 28 January, 2021, 2:24 pm

by Raymond J. Keating-

The Federal Open Market Committee statement released on January 27 noted, rightly, its assessment of the economy now and in the near term depends almost completely on the pandemic. However, when it comes to actual monetary policy, the Fed continues to be wildly disproportionate, and perhaps even detached from economic reality.

For now, the Fed noted: “The COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world. The pace of the recovery in economic activity and employment has moderated in recent months, with weakness concentrated in the sectors most adversely affected by the pandemic.”

And a bit later in the statement, it was pointed out: “The path of the economy will depend significantly on the course of the virus, including progress on vaccinations. The ongoing public health crisis continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook.”

It also wasn’t surprising that the Fed announced that it would maintain its target range for the federal funds rate at 0 to 1/4 percent.

More dubious was the Fed’s declaration that it “will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”

Why do so? The explanation offered was the following: “These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.”

This gets into the magical, fantasy-like world that the Fed too often ventures into, and that has especially been the case for more than a dozen years, since the credit mess hit hard back in the summer of 2008. The notion that the Fed needs to continue piling up asset purchases to make sure that credit is flowing to households and businesses is nothing less than bizarre. Just consider (in the following chart) what has occurred regarding the monetary base (currency in circulation plus bank reserves) since 2008, and how completely out of whack that is with anything historically.

Source: Federal Bank of St. Louis, FRED

And consider that prior to the pandemic striking, the monetary base stood at $3.45 trillion in February 2020. As of December, it had skyrocketed to $5.21 trillion. That was an increase in the monetary base in excess of $1.7 trillion in a mere 10 months. Over the same period, however, reserve balances jumped from $1.66 trillion in February to $3.14 trillion in December – an increase of nearly $1.5 trillion.

So, what has been the result of the loose money pushed not just since February of 2020, but since the summer of 2008? It’s hard to seriously believe that this massive expansion in the monetary base, without any precedent, has accomplished anything of substance in terms of aiding the U.S. economy. Nonetheless, every utterance from the Fed continues to gain vast attention. Why? Quite frankly, I’m no longer sure.

In the end, what might warrant some attention is what happens on the other side of this pandemic when it comes to the considerable uncertainties linked to monetary policy as the economy begins to recover and expand.

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



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