Friday, August 13, 2010

The Huge Inflationary Bias at the Fed

There's a tendency to want to support Kansas City Fed President Thomas Hoenig, who stands firm, and alone,  against the other voting members of the FOMC who are currently leaning towards an  aggressive money printing stance for the Fed. But, if Hoenig is the best friend the anti-Fed, anti-money manipulation crowd, has, we are certainly in a lot of trouble.

As  far as understanding the impact of current Fed policies, Hoenig really doesn't have a clue. In a speech delivered today at a Town Hall meeting in Lincoln, Nebraska, Hoenig said:
...the central bank is printing money to such an extent that zero interest rates bring little return to those who choose to save
Say what? Interest rates are not at zero. The effective Fed funds rate,which can be manipulated by the Federal Reserve, has been trading around 0.18%. The rate that the Fed has been paying banks on reserves is 0.25%. There is a big difference between these rates and zero. They are very low, but that is because the demand to hold cash and reserves is very high. The Fed has not been printing money to drive rates to these levels. Indeed, despite Hoening's statement about Fed money printing, up until recent weeks, money supply growth (M2) has essentially been flat for the last year. You can look it up.

There are huge vulnerabilities in the way the Fed is currently conducting monetary policy. Hoenig doesn't appear to understand any of them. If a financial Chernobyl hits, especially if it results in climbing rates, Hoenig, like the rest of the FOMC, will most certainly not allow rates to climb fast enough to fix a financial Chernobyl, since it's clear he doesn't look at money supply and appears to look at absolute interest rate levels, rather than understand the relative nature of interest rates. That is, he may be satisfied with a 50 basis point interest rate hike, down the road, even though such a hike still results in a huge explosion in money supply and only a 250 basis point hike in rates might stop a money supply torrent.

There is a huge inflationary bias built into the Federal Reserve, in part because members confuse interest rate policy with monetary policy. These are two different things. Right now Hoenig's confusion is causing him to take a defltionary stance, but because he doesn't understand the difference, between interest rate policy and money policy, under the right circumstances Hoening will be part of the inflationary problem along with the rest of the Fed members--at precisely the most dangerous inflationary point.

1 comment:

  1. And what point will that be Robert? Milton Friedman's transition mechanisim does not necessitate that money supply necessitate either inflation or deflation (though it is broadly misunderstood). Money supply is not "money". The only thing we have inflated is credit.

    Credit is the opposite of money (money antimatter if you will). At our current aggregate levels of private and public debt, we are one small step away from outright deflation and rising real interest rates. Rising real interest rates are hardly what one could argue constitutes "cheap" money. As debt becomes more onerous, the process of deleveraging accelerates as debt service becomes the most productive use of capital.