Monetary policy of the United States
2023.01.11 04:00
Monetary policy of the United States
Budrigannews.com – The US monetary tightening began in February 2021, the same month that the US monetary inflation rate reached an unprecedented 40 percent. Since then, the rate of monetary inflation has fallen to around 0%, and if the Fed has its way, it will fall even further in the months to come. Why is this crucial?
The primary reason for its significance is that changes in the monetary inflation rate, or the rate at which new money is created from nothing, drive the boom-bust cycle of the economy. More specifically, boom periods are characterized by periods in which the economy appears to be doing well and optimism is high (the boom phase), while bust periods are characterized by periods in which the boom-time investments were ill-conceived.
Major changes in the are linked to the major trends in the monetary inflation rate that drive the boom-bust cycle.
The yield curve is driven by changes in the monetary inflation rate, and a yield curve inversion occurs when the monetary inflation rate falls from a high level to a low level. That is, a downward trend in the rate of monetary inflation eventually results in both a shift in the economy from boom to bust and a flattening of the yield curve to the point where it becomes inverted.
The monthly chart that follows provides evidence of the strong positive correlation that exists between the yield curve and the monetary inflation rate in the United States. The monthly average of the 10-year-2-year yield spread is depicted in red on this chart as the yield curve. The True Money Supply (TMS) year-over-year percentage change is shown in blue as the monetary inflation rate.
TMS Vs 10Y-2Y Yield Curve Chart
One difference between the current cycle and previous cycles is that the Fed just started a campaign of monetary tightening when monetary conditions became sufficiently tight to push parts of the yield curve into inverted territory.
It is important to reiterate that the Federal Reserve is a Keynesian institution before responding to the question above. The economy can be compared to an amorphous liquid called “aggregate demand” within the Keynesian framework. The central bank and the government are responsible for adding or removing liquid to maintain the tub’s level within a range considered desirable. But in the real world, millions of people make decisions about production, consumption, and investments for a variety of reasons. As a result, there is no such thing as Keynesian “aggregate demand” in the real world, and it is absurd to think of the economy as a bathtub that policymakers can fill or empty to improve performance.
To return to the previous question, the Fed appears to believe that by becoming excessively “tight” in 2022 and 2023, it can make up for the recklessness of its actions in 2020 and 2021. At the very least, that is the only plausible explanation for why it began reducing its balance sheet by up to US$95 billion each month, thereby removing up to $95 billion from the economy each month, after the rate of monetary inflation had already decreased sufficiently to initiate the bust phase of the cycle.
In addition, the Federal Reserve appears to believe that by further tightening monetary conditions, it will be able to remove supply constraints imposed by COVID-related policies and anti-Russia sanctions, thereby addressing rapidly rising prices caused by supply shortages.
Taking money out of the economy won’t solve the problem of inflation if there has been a significant increase in the money supply. In point of fact, it will result in even more distortions of relative price signals and, as a result, more economic weakness. Stability in the money supply is desirable.
Therefore, the response to the query is no. The Federal Reserve appears to have no idea what it is doing, despite the constraints imposed by its fatally flawed Keynesian framework.
