Myths die hard in America. So it goes with the idea of the ‘Phillips Curve’ and the belief that an institution can control both labor market activity and inflation simultaneously. Even though Reagan & Volcker killed this ideological behemoth, the institutions that teach economics, especially post-graduate monolithic institutions, continue to keep it alive.
As of this writing, the Fed. has not been able to effect labor markets. It has damaged asset prices, which continue to spike. Asset infation is the new price spike.
With Jackson Hole wrapped up, I’d like to offer a few thoughts about going forward toward ‘normalization’, meaning policy briefs that permit markets to allocate/destroy. In a word: capitalism! Instead, American capital markets suffer from politically allocated forms of credit masking Fed. dependency. Will we ever return to normal?
Going forward, we need to do the following: get rid of ‘ZIRP’ (zero interest rate policy), return the Fed’s traditional mechanism of federal funds rate BACK into its indigenous portfolio. This means that the traditional mechanism used by the Fed is NO longer operational. It must be brought back to life IF capitalism is to survive. This over-night lending among banks to balance their reserves in compliance with the Fed’s capital ratio’s is a must. Macro-prudential oversight is a myth; its called crony capitalism. It’s what they do throughout Asian markets to build dominant market share. Dump Q.E. The Fed withdrew liquidity by selling T’bills to the banks; it increased it by buying T’bills. The reality of ‘high-powered’ money was always negligible. The Fed never really did ‘just print money’, it exchanged equal ratio’s of debt for cash. The absence of traditional interest rate control mechanism must be restored IF the Fed is to get a handle on money creation/inflation.
Instead, what the Fed has sought is the regulation of baseline money through payment of higher interest on excess reserves on deposit at the Fed. In reality, this is not a viable policy. Here the Fed seeks to persuade banks to tighten credit by bribing them with higher returns. This could dangerously wipe out the Fed’s own capital base. Remember, it only had $80 billion to return to Treasury, hardly enough to finance the kind of largess imaged by FOMC members. By making credit more expensive, the Fed would need to pay out to foreign owned institutions. How do you think that’s gonna play out domestically? And just why does the Fed wish to destory its own earnings?
Overnight borrowing by the Fed is called REPO. Its utterly laughable to think the Fed could manipulate so broad a market as the r.e.p.o. market. It would entail possessing knowledge of foreign capital markets as well as dominant foreign players like Russia, foreign commodities or sovergn funds like the House of Saud.
The Joint Chiefs have a saying: Mission Creep. The Fed possesses it now in spades.
It began when Fannie/Freddie received a dispensation from Treasury to dump their portfolio at the Fed’s door step. We still haven’t had a market sell-off of morgaged backed securites. We need one.
Here’s a thought George Melloan had: “If the Fed cannot control interest rates or the money supply or inflation, why does it think it can rule by fiat macro-prudentially?”