The Fed’s Messy Take on Policy and the Economy

By at 15 June, 2022, 6:08 pm

 These very messy economic times need clear, logical thinking and action by policymakers. Unfortunately, that’s not what we’re getting.

by Raymond J. Keating –

As the economy gets messier, the Federal Open Market Committee on June 15 issued its messy statement on monetary policy. That featured the announcement that the targeted range for federal funds rate would be increased by 0.75 percentage point to a range of 1.5 percent to 1.75 percent. For good measure, the FOMC stated that it “anticipates that ongoing increases in the target range will be appropriate.”

It also was noted in the statement: “The Committee is strongly committed to returning inflation to its 2 percent objective.”

Well, that’s nice, at least.

More importantly, the FOMC spoke about reducing monetary liquidity:  “In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities…”

As noted in the following chart, the Fed has a monumental task ahead if it’s serious about ridding the economy of the actual and potential ill effects of loose money that have served as looming uncertainties since the late summer of 2008, including the 2020-2021 spike in monetary liquidity feeding our current bout of inflation.

Source: Federal Reserve Bank of St. Louis, FRED

That process at least was restarted at the start of this year.

As inflation rages – the FOMC statement acknowledged that “Inflation remains elevated…” – and economic growth suffers, with real GDP declining by 1.5 percent in the first quarter, poor thinking regarding inflation and the economy comes into troubling focus. Namely, the mistaken notion that high inflation is fought by slowing the economy (hence, the Fed jacking up interest rates).

As a Wall Street Journal story on the Fed rate hike put it, “The Federal Reserve approved the largest interest rate increase since 1994 and signaled it would continue lifting rates this year at the most rapid pace in decades as it races to slow the economy and combat inflation that is running at a 40-year high.”

If one accepts that inflation is mainly a monetary phenomenon – you know, too much money chasing too few goods – then a policy agenda focused on slowing the economy, that is, slowing or reducing the production of goods, makes no sense. However, reining in the breathtakingly misguided expansion in the monetary base very much is needed.

If only the Fed could focus on that and leave interest rates to the market.

But more is necessary from other policymakers, namely Congress and the White House. They need to enhance incentives for entrepreneurship, investment and innovation – again, to boost the supply-side of the economy – and that is achieved via substantive, permanent, pro-growth tax and regulatory relief, advancing free trade, and reining in government spending. Unfortunately, this Congress and administration are focused on doing the exact opposite in each of these areas.

These very messy economic times need clear, logical thinking and action by policymakers. Unfortunately, that’s not what we’re getting.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.




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