There are quite a few people who are upset with the Federal Reserve these days. In a characteristically long and opaque post at RealClearMarkets, Jeffrey Snider declaims:
The economy is too complex to direct from the top, and any effort trying to manage this way will be as it has always been doomed to fail. This is why the entire purpose of any central bank was narrow in scope, once constrained to Walter Bagehot’s ancient dictum.
Focus on the money, let the real economy undertake the real work. Being unable to do the first part leaves these pseudo-central bankers grasping at their own analysis of the details – such as divining inflation rates and output gaps.
I suspect he doesn’t see it that way but Mr. Snider’s complaint can be interpreted as a plea for higher taxes. What’s the most direct way of reducing the supply of money? Taxation. Taxes are a means of removing money from the private economy. BTW, that’s how the present inflation puts a pin into the Modern Monetary Theory balloon. Increasing spending is politically possible, as we have seen. Raising taxes is a lot less so and it certainly cannot be done frequently or adroitly enough to operate the way MMT-ers advocate.
Unfortunately, far too many dollars are beyond the reach of the U. S. Treasury for taxation to be as effective a tool as it used to be anyway.
Meanwhile, Barry Ritholtz is even more critical of the Fed’s “quack policies”:
My job is not to give policy advice to the Fed, but to interpret what they are doing and its most likely impact on our portfolios. To paraphrase Ray Dalio, it is the role of the investor to see embrace reality and deal with it as it is.
Still, I cannot help but observe that the FOMC response to pandemic-induced inflation is blunt, excessive and unnecessarily painful to the middle and lower economic earners.
The Fed could learn from the Hippocratic oath: “First, do no harm.â€
They did harm by remaining on emergency footing of zero for way too long, and then missing the initial rise of inflation straight through their 2% target. Now, they are massively overcompensating by chocking off the economy to the point of recession.
The main point of his piece is that while 60% of inflation is due to excess demand the other 40% is due to supply bottlenecks but all of the Fed’s attention is focused on that 60%. My retort would be that a fundamental principle of optimization is to focus efforts where there’s a greater return. But, honestly, that’s not that much greater a return. I agree that more attention should be devoted to increasing supply. In fact I’ve been saying it for decades. There doesn’t seem to be much appetite for it.
Isn’t Ritholtz making a roundabout plea to raise the Fed’s inflation target from an average of 2%?
It isn’t new knowledge that the Fed’s toolset for fighting high inflation causes recessions and economic damage. That’s why the textbooks used to say the best thing is not to have high inflation in the first place so the Fed doesn’t use its toolset.
This (the push to accept higher inflation) maybe the policy debate to watch in 2023 — I’ve seen multiple Democratic-economists make similar arguments in the last several weeks.
As for taxation; its more precise to say “tighter fiscal policy”. If one increases taxes only to increase spending by a higher amount; as in the IRA, that actually makes inflation worse. (And yes the IRA increases outlays more then revenue does that for the next 4 years, its only appreciably tighter in years 5-9 if one assumes ACA subsidy expansion actually sunsets).
IMO the Fed does deserve criticism. They were too slow to act on inflation, and it looks like they could well be too slow to stop hiking interest rates.
What’s the most direct way of reducing the supply of money?
Changing banking, finance, and accounting laws would be more direct. The vast amount of money is created by the financial system.
(Before my PE Investor friend has a conniption fit, this is not an indictment of the financial industry. It is how the Modern Monetary System works.)
Yes, the Fed deserves criticism. Congress and the administration deserve it; arguably even more. Economists who ignored the data and said it was transitory inflation share a portion of the blame.
I don’t know how to frame the criticism that they are too slow on hiking interest rates. Despite best efforts, economics cannot be reduced to mathematical equations, but the analogy is its physical law that if you press the gas pedal and suddenly perceive the car is going too fast and maybe out of control, gaining control by slamming the brakes will hurt but it isn’t a choice. Soft landing may have been achievable if the Federal hadn’t pressed the gas in spring 2021 — but not slamming the brake when inflation is at 8% is risking an out of control situation.
I meant the criticism on being slow to stop hiking interest rates.
40% now, wonder what it was when the ships were lined up at the ports and there weren’t enough trucks?
Steve
Modern inflation is even less understood than the Modern Monetary System (MMS).
In a financialized, service-based economy, inflation is not a function of money. Increasing M0, M1, or M2 does not cause inflation because that money is quickly financialized. Those financialized dollars are used to produce more services and import more goods.
So, the phrase “inflation is a monetary phenomenon” is trite, at best. Since the MMS is credit-backed, inflation is a financial phenomenon, also.
For ten years, government borrowing increased substantially without substantial inflation. The financialized dollars were used for Facebook, Amazon, Twitter, housing, imported goods, stock market, etc. The increased demand was easily met with increased goods and services.
Today’s inflation is a direct result of COVID shutdown. Supply chain issues will take a decade or more to fix, and until then, there will be “rolling blockages”. As one blockage is relieved, it will cause other blockages, and at the end, it will roll around to the beginning.
Making matters worse is increasing energy costs, and apparently, this is “a feature not a bug”. Much of the cost to deliver imported goods from port to store (or house) are energy related, and most domestic services rely on energy intensive IT infrastructure. Re-shoring manufacturing makes the problem worse.
Additionally, many people have left the workforce. Illegals have gone home, older people have retired, and slackers have increased their legal weed consumption. So, wages have increased, but with out-of-control inflation, many will begin working again.
Today’s government borrowing is “throwing fuel on the fire”. They are not being absorbed by the financialized, service-based economy, like pre-COVID. Additionally, the leveraging ability of these financialized dollars is being stretched. Quickly inflating the price of existing over-priced assets brings the valuation into question.
A stock market crash or financial system collapse would quickly destroy a lot of dollars, but it would probably speed-up the process.
(For my PE Investor friend, I am not making any value judgements. This is the way it works, and many of the people bitching about it actually support it.)
Curious,
We will have to wait and see, but inflation is already starting to abate and the Fed seems set to keep raising rates. The actions taken so far may be sufficient if given time.