Page 17 - September October 2018 Disruption Report Flip Book

MONETARY POLICY
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Federal Reserve policymakers said they would forge ahead with further rises in interest rates, with some talking of pushing borrowing costs into restrictive territory, as the central bank seeks to prevent inflation from overshooting its target. Despite outspoken criticism of rate rises from President Donald Trump, a number of Fed policymakers said in their September meeting that they thought it might become necessary to temporarily boost rates above levels they expect in the longer run. This would prevent inflation from getting too hot and ward oft’ risks of financial excesses, the central bankers said. (Financial Times, Sam Fleming, 10/17/18)
The “very tricky operation” of unwinding the Fed’s huge balance sheet
In a MACROVoices podcast, Professor Steve Hanke warned of the dangers we face in quantitative tightening, saying:
...I think that the danger that lurks out there is quantitative tightening. The money supply is decelerating a little bit now and it hasn’t been over-hot [and] ...it’s starting to decelerate.
This is a tricky operation – a very tricky operation – unwinding this huge balance sheet that the Fed has built up. But remember we’re talking now about only 16% of the money supply is made up by the Fed. So there are things that they can do.
Right now, the commercial banks, for example, have massive excess reserve. And they have that because they’re getting paid interest on it by the Fed. So the Fed does actually have a tool that they could unleash commercial banks if they stopped paying interest on the excess reserves, or reduce the rate at which they pay.
So right now we have to watch very carefully what’s going on. But, of course, as I try to emphasize, you have to know what you’re watching for, what’s important. And it’s not what everybody is watching.
Everybody is watching the Fed funds rate. And interest rates are a very poor guide to monetary policy. They really don’t tell us very much. You’ve got to look at the balance sheet of the Federal Reserve and figure out how that is changing and monitor it, diagnose it. And that accounts for, again, a small portion of broad money.
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