It is often said that two wrongs do not make a right. Something similar might be said of Jerome Powell’s Federal Reserve. Two big monetary policy mistakes in the opposite direction do not make for the successful attainment of the Fed’s dual mandate of attaining price stability and maximum employment.
Last year, by pursuing an overly easy monetary policy, the Fed jeopardized its price stability objective while at the same time creating an equity and housing market bubble. The Fed contributed to a surge in inflation to a multi-decade high by keeping interest rates at their zero-lower bound for too long and by tolerating a ballooning in the money supply. It did so even at a time when the economy was recovering strongly and receiving its largest peacetime budget stimulus on record.
Meanwhile, the Fed contributed to unhealthy asset and credit market bubbles by flooding the market with liquidity. It did so by continuing to buy $120 billion a month in US Treasury bonds and mortgage-backed securities even at a time when the US equity and housing markets were on fire.
Fast forward to today, it seems that the Fed is unnecessarily risking the attainment of its employment objective by pursuing an overly aggressive monetary policy to regain control over inflation. Not only has it now raised interest rates in 75 basis point steps for the third time, something that it has not done in the past thirty years, and clearly signaled that interest rates will stay higher for longer. It is also now withdrawing market liquidity at the unprecedented rate of $95 billion a month by choosing not to roll over its maturing bond holdings.
One reason to fear a full-blown economic recession is the acute difficulties already being experienced in the housing market. Those difficulties have been caused by a more than doubling in mortgage rates from below 3 percent at the start of the year to over 6 percent at present. As a result, over the past year, mortgage applications have declined by 30 percent, housing has become the least affordable on record, and builder confidence keeps plumbing new lows. Historically it is the housing market that is most sensitive to Fed policy tightening and it is a housing slump that normally leads the economy into recession.
Another reason to fear a hard economic landing is that the Fed’s shift to a hawkish monetary policy stance has already caused the bursting of the equity and credit market bubbles.
Since the start of the year, the equity and bond markets have now lost around 20 percent in value. This means that at a time when household consumer confidence has already received a body blow from multi-decade high inflation, it is now having to deal with a major loss in household wealth. So far this year around $12 trillion, or some 50 percent of GDP in household wealth has evaporated with more losses to be expected should the Fed persist with its hawkish monetary policy stance.
The Fed now risks causing further equity and bond market declines by continuing to aggressively raise interest rates and by not rolling over $95 billion a month in its maturing bonds at a time when financial markets are already on the back foot.
Another reason for fear is that, by causing the dollar to surge and capital to be repatriated from the emerging markets, the Fed’s hawkish monetary policy stance is complicating an already very challenging world economic outlook. Europe is being sent into a recession by a Russian natural gas shutdown, China’s economic growth has ground to a halt as a result of its zero-tolerance Covid policy, and the World Bank is now warning about the risk of a wave of emerging market debt defaults.
If by early next year the Fed’s continued monetary policy hawkishness precipitates a world economic and financial market crisis, high inflation will become the least of our economic worries. However, the Fed will find that with an economy in a meaningful recession, while it might be on track to meet its inflation target, it will fall woefully short of meeting the high employment part of its mandate.
The Fed might have been better served by a 50-basis point interest rate hike today and by waiting to see the lagged impact of its monetary policy tightening to date.
Author Biography and Expertise: Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.
September 21, 2022 at 4:48 pm
Fed and powell are way overreacting by their excessive use of rate hikes.
This method will put US & world into a tailspin as greenback becomes greatly over valued and artificial shortages, supply disruption, panic hoarding, mass uncertainties and price blowups result.
Biden needs to leave white house and let harris take over to stop flow of endless dollars to endless warring in ukraine.
Do powell and biden know that 345 million people around the globe are facing severe food shortage and possibly outright hunger.
Most of large denomination greenbacks are found outside US and it’s time for biden and powell to give dollar printing press a break and stop flow of freshly minted cash to kyiv.
The prices of grocery items have gone through the roof and is biden fully ready for this coming winter.
Unlikely, and americans have responded by purchasing weapins and firearms and munition in unprecedented quantities waiting for all hell to break loose.
Thanks, Fed. Thanks, biden.
September 21, 2022 at 5:29 pm
Just wait until we have a food shortage later this year early next year.
The problem with the Fed is they don’t answer to us but control our economy. They care less about the damage to the economy only their balance sheet.
Time to bankrupt this bunk system and coin or own money. If govt was able to budget and appropriate the money they needed properly we wouldn’t have debt nor a need to accumulate it. WE ALL DO IT EVERY MONTH
September 21, 2022 at 7:06 pm
They have tried to make the CPI a nothing all year.
They have tried to hide rising gasoline prices by draining our SPR all fall and now its about 450 million barrels on hand losing at up to 10 millions per week. They will continue to drain the SPR through Election day to artificially keep gas prices down.
However a Refinery blew up in the midwest yesterday. That combined with natgas shortages in USA is going to increase costs for us going into winter making a mockery of the empty SPR that will now be refilled at whatever price above what was paid per barrel which will take away from Domestic Daily use and increase prices further.
So they raised the interest. Thats not raising the interest. When I was a teen back in the late 70’s they raised the interest on the order of 15 to 20%. Suddenly grandparents had a 10 to 15% increase in their social security and celebrated. One relative sunk everything not used each month into Treasury bonds which doubled in yeilds over time. He made a killing. THAT carried his part of the family over some really difficult times when one business was sold off due to the inflation then and the loss of customers.
Banks advertised CD’s at 15 to 25% interest into the early 80’s it was not long before the interest fell again leaving these banks unable to make money at all. They failed entirely. Poof no more bank. Raze the buildings and sell the land. The depositors got nothing in the end because they were not treated first in line by the liquidators and regulators as Creditors of the first row.
I remember inflation when the Gold Standard closed as a kid. In terms of Hershey Bars which quit selling for a time. They were then a nickel. Several of us kids got a quarter to go to the store and buy candy once a week. It was plenty back then to buy anything candy in the place.
A year later those candies became 15 cents 25 cents and so on. And got smaller too. The physical dollar bills changed. We had silver certificate 100 dollar bills in grey and blue in the kitty box at the house. No one bothered any of that then. Suddenly it became Federal Reserve Notes on paper and you needed much more of it for whatever. It was backed by nothing.
Congress started spending like a drunken sailor then during the inflation times. Stripped the Social Security Trust fund and other programs. Then papered it all over. Deficit was the thing then.
CPI was kept at zero or damn near zero for years fairly recently. We stopped using credit cards entirely. Went to all cash. We stopped the medical and other liabilities entirely. All cash. Budget to the penny every month.
That paid off in the last four years and continues to do so. Take gasoline. 5.00 gallon? Meh. 10.00 gallon? Meh. 15.00 gallon? Still meh. I can handle at my current needs each month about 130.00 per gallon. The problem is people who will shoot me to get it if I showed up with my 30 gallon tank and cash to pay for it. So a jerry can stock takes care of that problem in another vehicle. A proper Jerry can. Not the plastic shit that they sell in the stores now. Shuttle back and forth around the gas stations as needed until the 30 gallon tank is full.
When the precious metals made catalytic converters coveted again and being stripped quietly locally, I started keeping a gallon in the tank until it’s time to go somewhere. I hire a car now with cash. So it goes no where. If it got cut out I will need about 15 weeks and about 3000 dollars cash to pay the shop to put a new one in. I am in the process of buying a new converter outright to store it in my house in case. So I can just have a welder pipe it in if it did get cut. It also got painted high temp orange enamel which tells anyone in the dealer that is stolen.
Cash cash cash. Salmon 30 dollars a plate. Steaks up to 40 dollars a pair depending on cut. Omaha shipments is cheaper right now by weight. The package shows up occasionally for the freezer. Cash cash and more cash.
Electricity? Getting ready to pay it off annually. Its leveled and doubled already this year on paper. I owe the power company almost a years worth due to the leveling a few hundred dollars. Thats going to be paid off ahead of the bill on the 12th month going into winter. Then 3 months regular bills at a time so no bills will come. Electric use wont change.
Winter is going to be hungry. I already am buying anything and everything of certain items on sight. I dont care if the shelf is got one last of something left behind at any price. Coffee in particular. I’ll buy the damn thing even if it’s 50. I’ll take three thank you very much. Thats 150.00 Sir. Done. Paid. One is used a month, other two goes into pantry.
Any idiot can see what the Federal Reserve is doing with interest rates. Credit card collectors have sued me and frankly at some point the income will increase to where everything is paid ahead to the point that I can just buy them off with cash. I am working through the pile of old debts cash once a year.
A very long time ago a wise person taught me as a Banker that if someone bangs on your door demanding a bill to be paid, you pay $10.00 it could be a million dollar bill past due. But if you can prove to the court that you paid 10.00 good faith each month they cannot touch it. (To paraphrase) So in that way debt is really cheap.
I paid off the medical debts first. Those are the most dangerous ones. Then stopped doctors entirely as its about one to two thousand a year in copays and medicines out of pocket. Thats more cash to stay ahead of the inflation and shortages. Instead of buying one butter, I buy three at whatever sticker price walmart has the balls to print.
Thats the last thought I leave all of you. When you go shopping in walmart specifically MAKE SURE YOU HAVE A HUMAN CASHIER take your money, add up the cart and bag it. DO NOT USE THE SELF CHECK OUT.
Walmart sometimes have shortages and shrinks on inventory. They will go back months to everyone who used self check out hunting for who got how many of whatever is short. Then prosecute them for shoplifting etc. These are the ones who have no defense.
Where I live the line for a human cashier where there is four total is about 20 minutes long. No one uses the 30 or so self checkouts anymore at any price. And when the staffers invite us to break lines and go self checkouts we tell them we cannot risk our personal freedoms and future dollars defending against trumped up charges of stealing with those computer machines whenever they are short anything. We have a human cashier do it. 20 minutes versus 6 months waiting for trial in the county jail is easy.
We have also shifted to delivery for bulk foods such as Rice. Ship it. Cash. Three months worth at a time. Ship it baby. At some point thats going to absolutely stop when they dont have any rice at all this winter.
But we have some. And will feed people who need to eat when the time comes. It wont be much in that bowl but it will keep them alive. Youre welcome.
Interest? Meh. .75% is not raising it. 1% 4% meh. If you are going to raise the damn rates stop sniveling and be cowardly. Raise the damn thing 20% like they did back in the 70’s You will break the inflation essentially by morning when everything stops for a year or two.
otherwise the dribbling raises allows me the time to stay ahead of it with king cash baby.
At that point that will stop too and we have no money at all for anything. Join the club. We can sleep under bridges until our bodies fail in the winter and freeze to death towards morning. That wont hurt too much provided you get properly soused first before going to sleep for the last time in such a cold.