The Fed Pauses from …What?

By SBE Council at 1 November, 2023, 10:04 pm

SMALL BUSINESS INSIDER: The Economy

by Raymond J. Keating –

The Federal Open Market Committee decided to leave the federal funds rate in place in its latest announcement on monetary policy. That can either be seen as the Fed pausing in its fight against inflation, or the Fed pausing in its effort to further undermine the economy. Or both … I guess?

The Fed declared that it would “maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent.”

From the Fed’s perspective, and the views of many in the realms of policy, the media, and yes, economics, this is considered a pause in the Fed’s ongoing fight to bring down inflation through higher interest rates. As widely stated, the idea is that the Fed’s jacking up interest rates is supposed to dampen economic and employment growth, which is seen as the cause for inflation.

So, yes, in effect, the idea is for the Fed to undermine the economy to bring down inflation. The trick is, of course, to engineer a “soft landing.”

What few ask is: Does this make any economic sense?

In particular, if we accept the Economics 101 idea that inflation is caused by too much money chasing too few goods, this interest-rate-centered policy effort can leave many scratching their heads. After all, wouldn’t it be essential for the economy to increase the production of goods and services to counter inflation, and how does the Fed artificially manipulating interest rates help that? Hmmm.

The one thing that the Fed is doing that makes sense is trying to rein in the actual part of the money supply that it has direct control over, that is, the monetary base (i.e., currency in circulation plus bank reserves). In the FOMC statement, it was declared that “the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities…”

The monetary base, as SBE Council has hammered away at for years, moved into never-before-visited-or-even-pondered loose-money territory starting in the late summer of 2008. And despite the recent beginnings of trying to rein this in, policy remains in a loose-money fantasyland. (See the following chart.)

Source: Federal Reserve Bank of St. Louis, FRED

If the Fed could do more than pause in its jacking up of interest rates, and instead, leave interest rates to the market, while also getting even more serious about reining in the monetary base, then entrepreneurs, businesses, investors, and consumers would see a reduction in Fed-related policy risks and uncertainties, and that would be good news on the inflation, interest-rate and economic growth fronts.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest books on the economy are The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist and The Weekly Economist II: 52 More Quick Reads to Help You Think Like an Economist.