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Federal Reserve is ruling the swamp: Paul Heise

Posted 8/1/18

“At present, near-record high annual growth in the broadest U.S. money measure M3 is suggesting a significant inflation problem in the year ahead.”

So proclaimed the oracles of the …

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Federal Reserve is ruling the swamp: Paul Heise

Posted

“At present, near-record high annual growth in the broadest U.S. money measure M3 is suggesting a significant inflation problem in the year ahead.”

So proclaimed the oracles of the Federal Reserve in August 2008. To the experts, at the time sharply increasing M3 spelled inflation. We all remember October 2008, or at least we should. Inflation was not, and still is not, the problem except to the very wealthy.

The Federal Reserve Board manages the economy. They do this by buying and selling short-term government notes to keep interest rates at a target value and the economy growing at a sustainable rate. Inflation is seen as a threat to the wealth of the wealthiest so the Fed controls inflation above all. It does not try to control wages. When wages stagnate, as they have since 1980, the Fed accepts increasing income inequality and the consequent weakening of demand.

Theory says that the Federal Reserve, in the process of managing the economy, stimulates a lagging economy with the creation of money. Similarly, it takes money out of the economy to dampen demand and growth. The traditional weapon, buying short-term Treasury notes, seemed to be inadequate to the scope and size of the Great Recession. A sluggish recovery from the Great Recession and Financial Crisis led the Fed to use quantitative easing, supposedly the Fed’s instrument of last resort.

The only difference I see between traditional monetary policy and quantitative easing is the size and time frame. The lending of enormous amounts of money (trillions of dollars) is supposed to strengthen their balance sheet.

The banks hold most of the money that they borrow and just collect interest from the federal government to whom they lent it. Yes, you read that right. The banks borrow the money from the Fed at 1 percent and then re-lend it to the Fed at 2 percent. Anyway you look at it, 1 percent on $1 trillion is a lot of money.

The banks held about $700 billion in reserves when the exercise began. That jumped to $1.65 trillion, then $2.58 trillion. And then when the program was in quantitative easing, it jumped from $45 billion per month to $65 and then $85 billion per month. Mandatory purchase of bonds was more than $1 trillion per year. The total QE bank holdings were $4.5 trillion the year the program peaked.

There does not seem to be a strong consensus in regard to the effectiveness of the QE program. Alan Greenspan commented: there was “very little impact on the economy.” Researchers, bankers, bureaucrats and economists seem to agree that the program was probably valuable and maybe even something like it was necessary.

A New York Times correspondent listed the contributions: “lower interest rates for corporate bonds, higher stock market valuations, increased inflation rate, and investors expectations for future inflation and finally a higher rate of job creation and a higher rate of GDP growth.” It hardly seems worth it but “the impacts were to modestly increase inflation and boost GDP growth.” And the results were modest — except for the banks.

There you have it. The banks run the Federal Reserve which then works to protect the banks. In the jargon of the day, the Federal Reserve rules the swamp.

Paul A. Heise, of Mount Gretna, is a professor emeritus of economics at Lebanon Valley College and a former economist for the federal government.