Does the Fed Have Any Idea What It’s Doing?

By at 8 September, 2022, 11:25 am

Economic Insider 

by Raymond J. Keating –

Federal Reserve Chairman Jerome Powell took part in an interesting discussion, courtesy of the Cato Institute, on the morning of September 8 about monetary policy.

A few points jumped out, and further raised questions in my mind as to whether or not the Fed has any idea as to what it’s doing and what the effects of monetary policy are today.

First, the Fed chairman spoke about current policy focusing on slowing the economy, which would reduce labor demand, and thereby limit wage growth and bring down inflation. This again confirms that the Fed believes that further crippling an already troubled economy makes sense. That should be deeply troubling to everyone.

Second, Powell put forth that monetary aggregates don’t seem to matter anymore, or at least not right now, in terms of inflation. That, of course, raises major questions as to what exactly the Fed is doing. It would seem that the only issue then that matters to the Fed is manipulation of interest rates. In turn, that would point to increased attempts by the Fed to manipulate the economy, and increased risks and uncertainties regarding the Fed creating economic instability by going back and forth between hitting the accelerator and the brake.

Third, Powell was asked if the Fed will ever get back to a balance sheet aligned with history as opposed to the sky high levels of the monetary base (currency in circulation plus reserves) since 2008. (See the chart below for a refresher.) His answer was striking in that Powell basically said that it was unlikely that the Fed would return to pre-2008 balance sheet levels. As to why, that was unclear with Powell asserting that “ample reserves” made more sense given the volatility in monetary demand. The idea that the Fed’s unprecedented expansion in the monetary base over the past fourteen years has contributed to uncertainty in the economy, including, to some degree, to our recent bout of inflation, obviously does not factor into Powell’s thinking, or if it does, only to a periodic and mysterious degree. That too is troubling.

Source: Federal Reserve Bank of St. Louis, FRED

Unfortunately, my takeaway from this discussion with Fed Chairman Powell was that the Fed doesn’t seem to have a clue as to how to deal with inflation other than trying to undermine economic growth. That’s a dated view on inflation – that is, that inflation basically is caused by an overheated economy including the labor market – and disconnected from an economy that already is in a recession.

These are precarious times in that the Fed, the Biden administration and Congress all seem devoid of economic common sense, and are advancing policies that work against economic recovery and expansion, and therefore, by the way, against price stability. The U.S. is left with the hope that a private sector getting battered by public policy nonetheless has the strength and resilience to forge ahead.

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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