The Fed Is Finally Seeing the Magnitude of the Mess It Created – Investment Watch

by Ryan McMaken of the Mises Institute

When asked about price inflation in his Sunday interview with 60 minutes, President Joe Biden claimed that inflation “increased only an inch … almost not at all.” Biden continued the dishonest tactic of focusing on month-on-month price inflation growth to obscure forty-year highs in year-on-year inflation. This strategy may still work to placate the more ignorant voters, but people who are paying attention know that price inflation continues to rise.

So while Biden may pretend that this is all no big deal, the Federal Reserve knows it better do something about price inflation, which even the Fed now admits is showing no signs of even abating.

Other 75 basic points

On Wednesday, the Fed’s Federal Open Market Committee announced that it will raise the federal funds rate again by 75 basis points. According to the FOMC press release:

Inflation remains elevated, reflecting pandemic-related supply-demand imbalances, higher food and energy prices, and broader price pressures…

The Committee decided to increase the target range for the federal funds rate from 3% to 3-1/4% and anticipates that continued increases in the target range will be appropriate. In addition, the Committee will continue to reduce its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Federal Reserve’s Balance Sheet Reduction Plans they issued in May. The Committee is strongly committed to returning inflation to its 2% target.

This is by far the Fed’s most hawkish announcement from Powell, and certainly shows that the Fed has finally come to terms with the fact that inflation is not transitory—as the Fed has long insisted—and is now impossible to deny Last month, consumer price index (CPI) inflation rose 8.2 percent year-on-year, marking six months of year-on-year price inflation rates above 8 percent and near forty-year highs .

Also, in their summary of economic projections, many FOMC committee members said they expect the target policy rate to reach or exceed 4.25 percent this year and exceed 4.5 percent in 2023. The projections of economic conditions, however, remained relatively optimistic, with the The report suggests that gross domestic product (GDP) growth will remain above zero for the foreseeable future, while unemployment only reaches 5 per one hundred.

Despite two straight quarters of shrinking GDP, and despite many indicators of a recession in the making, such as falling home prices and the inversion of the yield curve, the committee still clings to the idea that the Fed can steer the economy toward a “Soft Landing” in which inflation will slow down with no more than a moderate slowdown in economic growth.

While recent increases in the fed funds target rate suggest an increasingly aggressive stance, the Fed nevertheless continues to take only the most lukewarm steps in reducing the size of its portfolio. This move would directly reduce the money supply by reversing quantitative easing (QE) and also reduce asset prices by producing a small deluge of government bonds and mortgage-backed securities returning to the market.

While the Fed is allowing some government bonds to continue to exit the portfolio, we shouldn’t expect any drastic moves here. It’s been nearly four months since the Fed announced plans to reduce the portfolio, but the actual reduction remains minuscule. Also, when asked about the Fed’s sale of mortgage-backed securities at a news conference on Wednesday, Powell replied: “It’s something I think we’re going to get to, but this time, the time to turn to- it hasn’t gotten there…. It’s not close.”

Even now, after immense and rapid price inflation over the past two years, the Fed is still too afraid of the fragility of the housing market to return much of its $2 trillion MBS portfolio to the sector private

That sends a mixed message about how much the Fed is actually committed to reducing price inflation, but it’s clear that Powell was trying to project a generally hawkish tone on Wednesday.

Powell talked about “significantly reducing the size of our balance sheet” and also stressed that ending the current bout of inflation will require pain in the form of job losses. He also stressed that there is no short-term solution, which clearly implies that the current effort to end inflation could take time. years.

Powell expressed the fear that price inflation will be much harder to tackle once the population comes to expect inflation to be the norm. He also noted that house price inflation “will remain high for some time.” Powell then reiterated that there is no way to “wish away” inflation, but that the only way the Fed can do something about inflation is “slowly.”[ing] the economy.” (See 1:35:00 here.)

However, the question remains whether the Fed and the federal government can politically tolerate a considerable period of rising interest rates and a decline in the rate of monetary growth.

A decline in the rate of money growth is a problem because it points to a recession. Our bubble economy is now so addicted to easy money that even a slowdown in monetary expansion can bring down the economy’s many zombie businesses. Raising rates is a problem because it can lead to a sizable increase in the federal government’s debt service payments. This could lead to a fiscal crisis without cuts in the spending programs of the popular government. Virtually nobody in Washington wants that.

Some key warning signs are already flashing ‘recession’, such as the investment yield curve. The ten-year yield minus the two-year yield has been negative since July and at its most negative level since the early 1980s.

This will put immense pressure on the Fed (from wealthy Wall Streeters, elected officials, and corners of the economic left) to return to quantitative easing.

Expect more attacks on the Fed’s tightening policy, but most of these attacks will set things back when it comes to understanding the problem with Fed policy. As even Fed economists are beginning to understand, the Fed must tighten now or risk truly runaway inflation in the near future. Many casual observers will then see this tightening as the “cause” of the economic pain that will follow.

However, the Fed real incompetence is now behind us. This happened during the last decade, when the Fed absolutely refused to end its quantitative easing efforts even though the economy was clearly in an accelerated expansion. This was especially evident after 2017, but Powell stuck with regular monetary inflation, because that was the most popular. Then when the covid crisis hit, all restrictions on monetary inflation were completely abandoned.

Now, thanks to Powell’s mistakes, price inflation is in overdrive, and even he admits it could take years of economic stagnation or decline to bring it under control. The sheer level of ineptitude would be shocking if it weren’t so common for central banks. For these people, their entire “strategy” can be summed up, as Peter St. Ong…”walk till it breaks, cut till it swells.“There’s not much more to it than that. That’s the best all these Fed doctors have come up with. Thanks to Powell and Yellen and Bernanke and Greenspan, we’re living with the aftermath of the Greenspan Put, followed by a decade of QE, followed by the “panic and print money” craze of the last two years. It’s great that Powell is finally finding out what the real world is like. Unfortunately it is years behind


Contact Ryan McMaken

Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Ryan holds a bachelor’s degree in economics and a master’s degree in public policy and international relations from the University of Colorado. He was a housing economist for the state of Colorado. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.

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