The Fed’s Bizarre and Messy Strategy

By SBE Council at 2 November, 2022, 8:22 pm

by Raymond J. Keating –

The Federal Reserve announced on November 2 that it would raise the federal funds rate by 0.75 percentage points to a targeted range of 3-3/4 to 4 percent.

The Fed added, “The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

The Fed seeking a two percent inflation rate is welcome. However, how the Fed is trying to get there amounts to an economic mess. Indeed, it’s hard to follow the Fed’s reasoning, but nonetheless, this is how the so-called “thinking” regarding how to fight inflation has gone for a long time.

Consider the current situation as summed up in the FOMC statement:

“Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures. Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity.”

There are issues worth raising here.

First, the Fed doesn’t acknowledge any culpability on its part for generating high inflation. But when we consider that inflation is mainly a monetary phenomenon, here’s a case of the Fed playing pass-the-buck politics. That, of course, is not new with this Fed.

Second, as for the sources for our current bout of inflation, the Fed points mainly to pandemic-related imbalances, Russia’s war, and vague mentions of higher food and energy prices, and “broader price pressures.”

Hmmm. If that’s the case, how then will the Fed jacking up interest rates in order to slow the economy – which already is doing poorly as we are suffering through stagflation – solve our problem of inflation? After all, how exactly do higher interest rates rectify pandemic problems (think supply chains and the need for more workers) and war? Of course, the Jay Powell-led Fed might simply be resorting to taking a sledgehammer to the economy in the hopes of restoring supply and demand balance? In fact, that seems to be the case.

Source: Federal Reserve Bank of St. Louis, FRED

As SBE Council has noted before, the only productive thing that the Fed has been doing since late last year is starting to rein in its 14-years-long, mind-blowingly excessive growth in the monetary base (currency plus bank reserves). However, as seen in the above chart, there’s a great deal to be done on that front, to say the least.

Action by Congress?

Meanwhile, Congress should act, not by browbeating the Fed or injecting itself into monetary policy decisions (we don’t need even more politics in monetary policy decisions), but instead by restoring the Fed’s main purpose.

The Fed’s dual mandate of price stability and maximum sustainable employment was imposed in 1977 by Congress. The amended Federal Reserve Act actually reads that the Fed must “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

This has been a source of policy mischief and much distraction from the lone job that a monetary authority actually can influence, at least in a positive way, and that is price stability. Return the Fed to the lone goal of price stability, and that in turn will serve as part of the foundation for a strong, healthy economy.

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.