Tag Archive for: FederalMonetaryPolicy

Crowding Out: The Fed May Be Killing the Private Sector to Save the Government

Estimated Reading Time: 2 minutes

The Federal Reserve’s balance sheet reached its all-time high in May 2022. Since then, it was supposed to drop at a steady pace and shed three trillion US dollars by 2024. The normalization of monetary policy was built on the idea of a soft landing for the economy. However, the Fed may be killing the private sector to save the government.

Curbing inflation requires a significant reduction in the money supply and aggregate demand. However, if government deficit spending is left untouched, the entire burden of normalizing monetary policy will fall on families and businesses.

The current situation is the worst possible. The Fed’s balance sheet is not falling as fast as it should; government spending has not even been scratched, but the money supply is falling at the fastest pace since the 1930s, and rate hikes are hurting the productive economy while the government seems unaware of the need to reduce its bloated budget.

The first-quarter GDP figure is extremely concerning. Government spending showed yet another big rise at +4.7 percent, much higher than expected. However, consumption, at +3.7 percent annualized, was well below estimates and driven by a worrying new record in credit card debt. Even more concerning, gross private domestic investment fell by a massive 12.5 percent.

There is robust evidence of a negative trend in the real economy. Rising federal expenditure, more bureaucracy, higher taxes, and weaker activity in the part of the economy that drives growth and jobs.

Rate hikes have two direct negative effects on the economy if the government does not reduce its deficit spending spree. They mean higher taxes and a massive crowding out of available credit. The government deficit is always going to be financed, even if it is at higher rates, but this also means less credit for businesses and families. The crowding-out effect of the public sector over the productive economy means lower productivity growth, weaker investment, and declining real wages as the government keeps inflation above target by spending additional units of newly created currency, but the productive sectors find it harder and more expensive to find credit. Additionally, the government borrows at a much lower cost than even the most efficient and profitable businesses.

It is impossible to achieve a soft landing for the economy when the Federal Reserve ignores the signals of the banking system and the real economy. The first pillar of a true soft landing must be to preserve the real disposable income of workers and the job creation and investment capabilities of businesses.

When the government continues to increase spending, there is no signal of the mildest budgetary control, and the entire “landing” comes from the private sector, what we get is upside-down economics.

The Federal Reserve has stopped paying attention to monetary aggregates just as the money supply is contracting at an almost historic pace. Even worse, the money supply is contracting but federal deficit spending is untouched, and the debt ceiling was raised again.

The money supply is collapsing due to the inevitable credit crunch and the difficulties faced by consumers and businesses. It is impossible to grow with rising taxes, persistent inflation—a tax in itself—and carrying the entire burden of the normalization of monetary policy.

Fighting inflation without cutting government spending is like dieting without eliminating fattening foods.


This article was published by the Ludwig von Mises Institute and is reproduced with permission.

Even When There Is Inflation, the Fed STILL Fights Falling Prices

Estimated Reading Time: 5 minutes

Under any remotely sound money regime, the aftermath of war and/or pandemic is highly likely to feature a sharp decline in the prices of goods and services on average. Even under unsound money regimes, there are powerful forces operating towards lower prices once the war/pandemic recedes. Strong injections of monetary inflation, however, can overpower them.

The Fed and all the foreign central banks which follow its lead and/or doctrines are apparently of the intention that this time the decline in prices will not take place. Instead, they state the aim of their monetary policies, to be achieved within two years, as a decline of the inflation rate from present near-term highs to 2 percent.

In combatting the powerful “natural rhythm” of prices downwards in the aftermath of pandemic and war we should expect the Fed and foreign central banks to marshal a tremendous amount of monetary power. That will occur beyond an intermission where central banks are ostensibly trying to rein back the monetary inflation which has reached its peak virulence in 2021–22.

Precise measurement of monetary inflation, including its stages, is impossible under the present monetary regime where the supply and demand conditions for monetary base—and the attributes of base money—have been deeply corrupted. In thinking about the next monetary inflation injections, history provides considerable insight.

The aftermaths of supply shocks are full of inflation danger, even though recession intervenes and mitigates this for some time. Monetary inflation has accompanied all the great supply shocks and sometimes preceded them as in the present case of pandemics and war. Here monetary inflation stretches all the way back to 2012/13.

In the aftermath of World War I and the Spanish flu pandemic (1918–19), US consumer prices fell by around 20 percent (from mid-1920 to end-1921). The fall in prices stemmed both from deliberate monetary deflation (starting in late 1919 as the Benjamin Strong–dominated Fed sought to reverse the monetary inflation in the half-year following the armistice) and the easing of supply restraints (with huge gluts developing for many primary commodities).

After World War II there was an almost 5 percent decline in CPI from mid-1948 to the end of 1949, overlapping the recession of November 1948 to October 1949. There was no sudden substantial monetary policy tightening during that time. But the around 30 percent rise of consumer prices during 1946–47 coupled with the constancy in the outstanding supply of high-powered money stock meant this shrunk far in real terms. Accordingly, the overhang of excess money supply dwindled.

Towards the end of the Korean War (1950–53) and into its aftermath consumer prices were relatively flat (mid-1952–55), having risen by almost 12 percent between mid-1950 and the end of 1951. That was despite the McChesney Martin Fed following an inflationary monetary policy as evident first in asset inflation and later in an eruption of consumer price inflation (the second half of the 1950s). In effect, the “natural rhythm” downward of prices as wartime constraints eased and a sustained leap in productivity growth got under way meant that monetary inflation did not produce at first the symptom of consumer price inflation.

Toward understanding the potential strength of price reductions in these examples, we turn to the concept of the “natural rhythm of prices,” already highlighted in the above summary. “Natural rhythm of prices” transcends and goes well beyond the familiar statistical distinction between overall CPI inflation and so-called core inflation (which strips out food and energy). It refers to persistent moves in an upward or downward direction of prices of goods and services which are not attributable to money supply veering persistently ahead of demand (monetary inflation) or below demand (monetary deflation).

Why “natural”? Because the direction of price change as measured in aggregate is in harmony with how real economic changes underway would influence the pricing decisions of individual firms (if indeed there were no offsetting monetary forces thwarting this).

For example, during an economic expansion when productivity growth is surging, firms in competitive sectors would tend to cut prices in line with falling costs as brought about by efficiency gains. Incomes would rise faster in real terms than in nominal terms. Correspondingly the path of demand for money would not shift substantially and remain broadly in line with the slowly growing money supply. Hence, under a sound money regime, declining prices would be consistent with no monetary deflation or inflation.

Turn next to the natural rhythm of prices in the context of the economic journey from the pandemic and/or wartime shortages to resource abundance. The increased scarcity of supplies prompts many businesses to raise their prices. At the same time, the shortage including dislocations goes along with a fall in real incomes. So, overall demand for money might not change significantly (unchanged pace of growth in nominal incomes made up of some decline in real terms and big price rises). If the money supply is on an unchanged low path, then the increase in prices does not signify monetary inflation. Correspondingly there would be no symptoms of asset inflation.

By the same token once peak scarcity has been reached and resources become more plentiful, real incomes rise, prices fall, and the demand for money would still be in line with very slowly growing supply. Falling prices would not indicate monetary malaise but natural rhythm.

In the actual context of the massive fiscal “stimulus” in the US during the pandemic, most households felt much better off even though for society as a whole it was a period of hardship. Real disposable incomes and real demand for money increased; money supply veered far ahead of money demand but not by as much as first appearances might suggest.

Even so, we can say that the increase in underlying prosperity in aftermath of a pandemic and/or war means that the demand for money in real terms is likely to be increasing by more than normal. A fall in prices would be consistent with money demand rising in line with the slowly growing money supply.

Instead, the central scenario is surely that the Fed has flooded the system with so much money (only some of the excess removed during the period of hawkish turn and taking account of cumulative price rises) that the natural downward rhythm of prices will not show up in outward reality. Rather, the Fed will use the relief from symptoms of inflation in the consumer price data to double down on monetary inflation. This would show up at first in a new episode of asset inflation. It will be boom time for government collections of monetary repression tax (this corresponds to interest rates manipulated by the central bank at artificially low levels whilst CPI inflation remains low).

It is not too early for investors or the more general public to concern themselves about the next wave of monetary inflation. Many worry that the Fed may pull back from monetary tightening on the first signs of recession rather than completing the task of bringing inflation back down to 2 percent and keeping it there. That is likely to prove a false version of the problem.

More likely the Fed will keep tightening policy into the first stages of the next recession—that is just par for the course. Inflation may fall below the banner 2 percent. Then the Fed will unleash a powerful monetary stimulus rather than simply allowing the money supply to continue growing at a slow pace with a powerful natural rhythm of prices downwards pulling the economy forward.

The monetary inflation of 2012–22 is dead! Long live the monetary inflation of 2023 onwards!


This article was published by the Ludwig von Mises Institute and is reproduced with permission.

When Did The Fed Change Its Tune?

Estimated Reading Time: 5 minutes

The Federal Reserve is finally taking a tougher stance on inflation. The Federal Open Market Committee (FOMC) raised its federal funds rate target by 50 basis points in May. It will likely raise its target by another 50 basis points when it meets in June—and then again in July. Fed Chair Jerome Powell has acknowledged there “could be some pain involved in restoring price stability,” but nonetheless concludes that “it’s something we have to do.”

To some, the Fed’s recent tightening appears to be too little, too late. The personal consumption expenditures price index (PCEPI), which is the Fed’s preferred measure, has been elevated for more than a year and began accelerating last October. But the Fed left its target rate unchanged until March and did not significantly change course until May. Even then, its move looked modest compared to the prevailing inflation. Bond markets continued to price in more than 2 percent inflation per year over the next ten years.

Why did the Fed wait so long to address the inflation problem? One might argue that Fed officials just didn’t realize inflation was much of a problem until it was far too late. However, this view appears to be inconsistent with most FOMC members’ projections of inflation, which exceeded 2 percent in March 2021 and have been ratcheted up each quarter thereafter. It also appears to be inconsistent with FOMC statements, which suggest Fed officials understood there was an inflation problem by mid-December 2021.

FOMC Statements

The FOMC releases a statement after each meeting to summarize its assessment of the economy and indicate how it will adjust monetary policy, if at all. These statements are carefully worded and do not change much from meeting to meeting. When changes occur, therefore, it provides some indication as to how the thinking of Fed officials has changed. In what follows, we identify significant changes in FOMC statements over the last fourteen months.

March 17, 2021 : “… Inflation continues to run below 2 percent. …”

At the onset of the pandemic, the price level fell below the growth path consistent with the Fed’s 2 percent inflation target. It did not return to that growth path until March 2021. Of course, it takes time to collect and report data. When the FOMC met on March 17, it had PCEPI data for January (released on February 28) and Consumer Price Index (CPI) data for February (released on March 10). Given the available data, it was reasonable to conclude that inflation remained below target—and that’s what the Fed did.

April 28, 2021: “… Inflation has risen, largely reflecting transitory factors. …”

When the FOMC met in late April 2021, it had PCEPI data for February (released March 26) and CPI data for March (released April 13). Based on this new information, the Fed changed its assessment. It acknowledged that inflation had risen, but attributed this to transitory factors. It did not expect inflation to remain elevated.

June 16, 2021: “… Inflation has risen, largely reflecting transitory factors. …”

July 28, 2021: “… Inflation has risen, largely reflecting transitory factors. …”

September 22, 2021: “… Inflation is elevated, largely reflecting transitory factors. …”

The FOMC continued to attribute the high inflation to transitory factors through September 2021. When it met in September, it had PCEPI data for July (released August 27) and CPI data for August (released September 14). Prices were clearly elevated. The July PCEPI data showed prices were 1.4 percentage points higher than the 2-percent growth path projected from January 2020. But the primary cause of higher prices was less clear.

If prices were elevated due to pandemic-related supply constraints, they could be expected to come back down when those constraints eased up. If, instead, they were elevated due to a surge in nominal spending, the Fed would need to take action to bring prices back down (or, see them remain elevated permanently). Fed officials apparently accepted the supply constraint view, maintaining that inflation was largely transitory.

November 3, 2021: “… Inflation is elevated, largely reflecting factors that are expected to be transitory. …”

The FOMC began changing its tune in early November 2021. Whereas it had previously attributed high inflation to “transitory factors,” it now attributed it to “factors that are expected to be transitory.” It was a small admission of doubt from a hitherto confident Fed.

Doubt about the transitory nature of inflation was certainly in order by early November. The FOMC had PCEPI and CPI data for September (released October 29 and 13, respectively), at the time. It knew prices had outpaced FOMC member projections (which had been revised up in both June and September) and were now 2.3 percentage points higher than the 2-percent growth path, despite relaxing supply constraints and strong growth in real output and employment.

December 15, 2021: “… Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. …”

The FOMC statement changed significantly in December 2021. The “transitory” term had been dropped entirely, in line with Chair Powell’s comments on November 30. The statement also acknowledged demand-side factors were contributing to inflation, which implied that prices would not return to normal unless the Fed took action to bring prices back down.

Somewhat surprisingly, given the clear change in the FOMC statement, the Fed did not take action to bring prices back down. It left its federal funds rate target unchanged in December and January. It made a modest 25-basis-point hike in March and then left its target there until May. In April, The Economist magazine asked whether the Fed could pull off an ”immaculate disinflation.” The Fed recognized prices were too high. But it was not doing anything to bring prices back down beyond hoping they would decline on their own.

January 26, 2022: “… Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. …”

March 16, 2022: “… Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures. …”

May 4, 2022: “… Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures …”

In the January, March, and May 2022 statements, the FOMC continued to acknowledge that demand-side factors were contributing to inflation. It added “energy prices” and “broader price pressures” as contributors in March, reflecting the Russian invasion of Ukraine (and corresponding supply disturbances). But, otherwise, its statement was largely unchanged.


Monetary policy is difficult in real-time. Data is collected and released with a lag. Policy decisions have delayed effects. It is difficult to know what and how much to do in the moment.

The FOMC statements suggest that, by December 15, 2021, Fed officials understood inflation was at least partly the result of demand-side factors and, hence, needed to be brought down to some extent with contractionary monetary policy. And, yet, the Fed largely failed to act until May 2022.

One might excuse Fed officials for being late to recognize the inflation problem. Reasonable people can disagree about when the Fed should have known inflation was too high. But there is no excuse for the considerable delay before acting once the problem had been recognized. Perhaps a December 2021 rate hike would have spooked markets, as the Fed had just revised its view and had not had time to conduct forward guidance. But the Fed had opportunities in January and March. And it could have called a special meeting in February or April. Instead, it waited until May.

The Fed could have—and should have—taken prompt action to bring down inflation. It didn’t. Now inflation is much higher—and much harder to deal with—than it otherwise would have been.


This article was published by AIER, American Institute for Economic Research, and is reproduced with permission.