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Opinion: Too slow and too predictable, the Fed is its own worst enemy

And without a hard debt ceiling to constrain government borrowing, too much money will continue to circulate, worsening inflation

The Federal Reserve has raised interest rates 75 basis points, or ¾ of 1 percentage point.  Even so, it remains at historic lows with a mostly downward trend since 1980.

Nicholas Dwork

The Fed has two mandates: full employment and price stability. Both are impacted by its interest rate, and by the amount of money available for spending and investing — also known as liquidity.

Raising rates has an indirect impact on liquidity and economic activity. The Fed also controls liquidity in other ways: open-market operations (e.g. changing the fractional reserve requirement for banks), and purchasing government bonds and mortgages. By reducing liquidity, the Fed attempts to lower economic activity and, with demand falling, reduce inflation.

The Fed, though, is facing a new obstacle in its effort to reduce liquidity: an ever-increasing debt ceiling.

Current inflation is a result of the Federal reserve making too much money available for far too long, along with simultaneous government constraints imposed on production. These constraints, argued to be essential for protection during the COVID-19 pandemic, have been ineffective. The evidence of this is the similar infection and mortality rates across states that imposed drastically different levels of restrictions.

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The resulting disruption is felt throughout the economy. Most recently, there has been a lack of supply of baby formula. As an example of the very questionable restrictions imposed by our government on the economy, even though the formula has been approved by European regulatory agencies, most European formula is prevented from use in the United States.  Even during this time of shortage, only those companies that have met the additional stringent requirements of the FDA, including ingredients labeled in the correct order, are prevented from seizure by customs.

In the face of such urgent circumstances, the Federal Reserve has responded with unhelpful restraint.  “When changing the trajectories of inflation and employment, acting early is far better,” former central banker and former hedge fund manager Neil Grossman told me. “It allows you to do less and have more impact. Rates have to get restrictive. The idea that a rate of  2-2.5% is neutral in this environment is just silly.”

The Fed’s slow-footedness is exacerbated by its current habit of revealing probable future actions. “The idea of transparency with monetary policy is bad. When the Fed telegraphs everything, they take risk out of the equation,” Grossman told me. “This can create significant distortions. Removing liquidity in a slow predictable way lowers the impact of these actions.”

Indeed, as Fed Chairman Jerome Powell’s last press conference shows, the Federal Reserve is revealing all thoughts. Powell announced, “I do not expect moves of this size to be common. Either a 50 (basis points) or a 75 (basis points) increase seems most likely at our next meeting.”

The Fed’s current interest rate is 1.5-1.75%. And now, the government’s debt ceiling is no longer imposed as it once was.  The ceiling was intended to be a limit on the amount of dollars that could be borrowed, but not a limit on debt repayments. So the Federal government could borrow at any interest rate.

But now, increases to the debt ceiling are merely an occasional procedural ceremony. The government’s annual budget is currently $6 trillion. By continually raising the limit, the government can increase liquidity — the availability of money — to any arbitrary amount regardless of the interest rate set by the Federal reserve, which increases inflation.

Note that the Biden administration 1) does not admit that the current inflation is the result of any increased spending, and 2) believes that further increasing spending can reduce inflation. Recall that Biden claimed the Build Back Better program, which would increase government expenditures by approximately $5 trillion over 10 years, would reduce inflation. Thus, the current administration may try spending our way out of inflation. This runs counter to all economic principles centered on the laws of supply and demand.

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By printing additional dollars, the government can make additional purchases. The resulting inflation is felt as a burden only by the constituency. Therefore, the only possible negative consequences are political. That is, we (the public) may vote our representatives out for the recession they’ve caused.

As democrats currently control the executive and legislative branches of the federal government, they must make a case for remaining in spite of this dire economy. Their efforts to do this include reviving any disdain for former president Trump and associating him with current Republicans (e.g. calling republicans Ultra-MAGA); promoting their acceptance of transsexuals including transexual education in early elementary school and supporting transitioning procedures for children; holding hearings about the January 6th riot at the capitol building; and supporting late-term abortion.

If they succeed in convincing the public that 1) these are more important issues and 2) they have the correct position on these issues, then our representatives will not face any consequences for this inflationary tax.

The choice, as it always is, will be up to us. Whoever gets elected, a significant fiscal restraint will be required to return purchasing power to the dollar and prevent burdening our children with even more debt.


Nicholas Dwork lives in Arvada.


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