trimming the $4.5 trillion balance sheet simply by not reinvesting the proceeds of some of its maturing Treasurys, and instead letting the principal shrink by about $10 billion a month initially, and then letting that grow to as much as $50 billion a month as time goes on.
How did the balance sheet get so big that it's now a quarter the size of our entire economy? It was built up over eight years of buying Treasury and mortgage bonds, in the mistaken notion that massive Fed cash infusions into those markets would bolster the economy and foster a return to normalcy.
Instead, like a patient put on a respirator for too long, the economy didn't thrive. During the Fed's balance-sheet buildup and its zero-interest rate experiment, the economy grew at a tepid 2% rate, a full third below its long-term average. During that period, as a result, the U.S. by our own conservative estimate suffered the loss of at least $2.3 trillion in potential GDP growth. These policies stimulated nothing.
Fed's 'Great Unwinding' Begins, And It's About Time — Now It's Congress' Turn To Act
6:44 PM ET
Monetary Policy: The Fed, after eight years, has finally declared its war against the financial crisis of 2007-08 is over. Like so many other wars in this nation's history, it should have been over long ago.
Now, the "Great Unwinding" begins. On Wednesday the Fed officially began its long, and no doubt eventful, process of unwinding its massive balance sheet, built up in the aftermath of the Great Recession in one of the biggest, and most misbegotten, monetary experiments in economic history, dubbed Quantitative Easing.
Beginning next month, the Fed said it will begin trimming the $4.5 trillion balance sheet simply by not reinvesting the proceeds of some of its maturing Treasurys, and instead letting the principal shrink by about $10 billion a month initially, and then letting that grow to as much as $50 billion a month as time goes on.
How did the balance sheet get so big that it's now a quarter the size of our entire economy? It was built up over eight years of buying Treasury and mortgage bonds, in the mistaken notion that massive Fed cash infusions into those markets would bolster the economy and foster a return to normalcy.
Instead, like a patient put on a respirator for too long, the economy didn't thrive. During the Fed's balance-sheet buildup and its zero-interest rate experiment, the economy grew at a tepid 2% rate, a full third below its long-term average. During that period, as a result, the U.S. by our own conservative estimate suffered the loss of at least $2.3 trillion in potential GDP growth. These policies stimulated nothing.
No, we don't blame the Fed for everything that went wrong with the economy over the past eight years. There's plenty of blame to go around. But by now it's pretty clear that the Fed's meddling and 0% interest rate policy distorted both interest rates and financial markets for years, making it difficult to discern genuine market signals from Fed-created noise. That's never healthy in a market-based economy.
In remarks ending its two-day meeting on Wednesday, the Big Bank left open the possibility of a quarter-point rate hike in December and at least three more next year, despite Federal Reserve Chair Janet Yellen calling it a "mystery" why inflation continues to be a no-show (below 2%) in a growing economy with low unemployment.
Actually, it's no mystery at all. It's a myth that economic growth and job gains cause inflation. The real world record is pretty clear on that. The link exists mainly in Keynesian economists' model spreadsheets, and nowhere else.
And even nonexistent inflation may not stay the Fed's tightening hand. As Yellen said, "We want to be careful not to allow the economy to overheat to somewhere later on to have to tighten monetary policy rapidly and ... cause a recession."
Unfortunately, because the Fed has been so reluctant to raise rates, the fed funds rate, now targeted between 1% to 1.25%, is way below where it should be. With inflation just under 2%, current real interest rates are negative. And despite Yellen's comments, central bank policymakers still worry that rate hikes will tank the economy just as it seems set to grow at a healthy clip.
By the Taylor Rule, a widely popular alternative measure used by economists to gauge where interest rates should ideally be, the fed funds rate should be 3% or higher right now. The Fed's way behind the curve.
Even so, in the short-term, Fed interest rate policy probably won't matter all that much even if, as expected, the Fed hikes rates in December. Because rates are so far below where they should be, small changes likely won't be a big deal. But the unwinding of the Fed's balance sheet will be: It will put upward pressure on market rates for at least the next two years.
If the Fed's not that important, what will be? More important to the U.S. economy will be fiscal policy, from both Congress and the Trump White House: tax reform, deregulation and the repeal of ObamaCare, the largest and most ruinous tax hike in recent history. Those changes will swamp anything the Fed does in the next couple of years.
In unwinding its enormous balance sheet and trying to restore some normalcy to interest rate policy, our nation's central bank has done the right thing, so bravo. But it's no longer the driver of the U.S. economy. If the economy crashes and burns, don't blame the Fed. No, this time it will be Congress' fault for not acting on its greatest chance in decades to pass a real growth agenda. |
