Inflation: Raise rates or sell assets

In order to tamp down inflation, the Federal Reserve has started a program to raise its key interest rate target.  On June 15, the Fed raised the federal funds rate target by 75 basis points, the biggest such rate hike since 1994.  The Fed's rate hikes have caused and will cause a rise in other interest rates.  The rates for home mortgages have already risen.  And for savers, commercial bank deposit rates are also inching up — it's about time. 

Inflation is the highest it's been in 40 years.  That takes us back to the early 1980s, the era of Fed chairman Paul Volcker.  The official inflation rate of the '80s topped out at 14.8% in March of 1980, whereas today's rate is 8.6%.  Inasmuch as the Fed under Volcker raised the federal funds rate to 20%, today's Fed has a ways to go with its current 1.75% rate

In order to kill inflation in the 1980s, Volcker deliberately precipitated a recession, for which he was roundly criticized.  Inflation, however, is the great killer of currencies, and even of nations.  So Volcker's Fed had to undertake unpopular measures.  They could not allow garden-variety inflation to swell into hyperinflation.  Volcker also had to battle a new type of inflation called "stagflation," which violated the economic theory of the time.  In any event, inflation fell to under 3% by 1983, and President Reagan was re-elected in a historic landslide.

Today's woke Fed under Chairman Powell has been criticized for not being sufficiently aggressive in tackling inflation and for not acting sooner.  Some urged a 1% rise in the funds target rate rather than the 0.75% hike.  (I believe I heard some TV analyst say the funds rate should already be at 10%.)

Powell's Fed is hoping to engineer a soft landing and avoid a recession.  That's quite a contrast with Volcker, who embraced recession in order to vanquish the greater evil: inflation.

The contrast between 1980 and 2022 is stark.  For one thing, 1980 was less than a decade after we went off the gold standard; America had more of a "sound money" philosophy back then.  And, since 1980, Congress has added more than $29 trillion to the federal debt, debasing the currency.  And, since the 2008 financial crisis, the Fed has been printing trillions of dollars in Q.E. (quantitative easing) to buy assets, like U.S. treasuries.  There was a huge spike in Q.E. during the pandemic (which may still be going on).

What that suggests is that Powell has a tool that Volcker didn't really have: a huge portfolio of assets that the Fed acquired with Q.E. that the Fed can sell to draw money out of circulation, and thereby reduce inflation.  It's the Fed's "balance sheet."  The Fed didn't have a huge balance sheet in 1980, so it had little to sell to suck money out of the system.  Volcker seems to have performed his magic with interest rate hikes alone.  So Powell may not need to hike the funds rate to 20% like Volcker; he can sell assets instead.

Powell needs to begin a program of quantitative tightening, or Q.T., in which he sells off the Fed's balance sheet.  But will he?  If he doesn't launch Q.T., it will support the notion that the Fed is the poodle of Congress and the asset-owning class.  Asset prices need to fall.

Make no mistake: the Federal Reserve, under Bernanke, Yellen, and now Powell, created this frightful inflation vortex in which we're swirling.  The easy money of ZIRP and Q.E. after the 2008 crisis went on for far too long.  Regular old garden-variety Q.E. morphed into QE Infinity.  And now the Fed's chickens have come home to roost (pardon the cliché).

Of course, selling the Fed's assets that it acquired in quantitative easing in a program of quantitative tightening will push the dread Day of Reckoning off into the future.  But we have a serious situation to deal with now.  If we want to soften our problems in the future, then Congress should end its infernal borrowing and spending now.

The problem is that Chuck and Nancy want to continue the borrowing and spending, and they expect their pet poodle, the Fed, to keep printing the money for them.  After all, the influx of "undocumented Americans" (sic) walking across the border need new cell phones and plane tickets and so much more, and that all takes money.  Chuck and Nancy think inflation, the currency-killer, can be dealt with some other time.

The Fed's funny money is no longer amusing.

Jon N. Hall of ULTRACON OPINION is a programmer from Kansas City.

Image: National Archives.

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