Interest money

Is a big monetary policy reset coming after a massive money supply expansion?

In response to the coronavirus pandemic, the Federal Reserve has taken extraordinary and unprecedented action to cushion the economic blows resulting from the global health crisis.

Over the past two years, the central bank extended the money supply of more than 6 trillion dollars. The pandemic-era round of quantitative easing led to the creation of almost 50% of all new US dollars ever created in the country’s history.

When Congress approved trillions of dollars in new government spending, whether it was the $2.1 trillion CARES Act or the $1.9 trillion US Rescue Package (ARP), the Department Treasury issued new debt to cover the huge deficit. This prompted the central bank to issue new currency units to buy the debt.

The Fed didn’t just buy Treasury debt. The institution also acquired mortgage-backed securities and corporate bonds. That took its balance sheet to a record $8.9 trillion.

In a March 2020 interview with “60 Minutes,” Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, Noted that the Fed has “unlimited liquidity,” assuring the public that the financial system has enough money.

Uncle Sam’s Wallet

Critics accuse the Fed of allowing officials to embark on huge deficit-financed spending efforts by monetizing debt. This could exacerbate US finances, with fiscal consequences for the federal government and the American people.

A Peterson Foundation billboard displaying the national debt is pictured on K Street in downtown Washington, Feb. 8, 2022. (Jemal Countess/Getty Images for Peter G. Peterson Foundation)

The national debt has topped $30 trillion, the federal deficit is expected to remain above $1 trillion for the next decade, and the government is saddled with $200 trillion in debt and unfunded spending. But financial experts warn that debt service payments could skyrocket in coming years, especially if the Fed continues to raise interest rates to fight inflation. Last year, for example, the US government spent more than $500 billion in interest on debt held by the public. With the benchmark federal funds rate expected to reach 3.4% by the end of 2022, officials will pay more to service the national debt. By 2031, Washington’s net interest charges are predicted increase to nearly $1 trillion per year (based on a 2.8% interest rate on the 10-year Treasury by the current administration).

Moreover, debt can become a massive burden for the country when it swallows up domestic production. Economists warn that a country’s red ink reaches a tipping point when the debt-to-GDP ratio exceeds 77%. Today, the debt-to-GDP ratio is around 125 percent.

If there is a hint of national debt concern, Treasury investors will demand higher compensation for the increased risk. Additionally, it may threaten the greenback as the value of the dollar declines if there is a drop in demand for US bonds.

Market analysts claim the Fed is juggling: fighting inflation while maintaining economic growth. But there could be another feat the central bank needs to accomplish: fighting rising prices without a severe hemorrhage from federal government finances.

Suffice it to say that the higher the national debt grows – it is expected to reach around $40 trillion over the next decade – the greater the challenge for the Fed to raise rates above inflation levels.

Is the debt sustainable?

Experts have sounded the alarm over unsustainable debt levels.

“National debt may be sustainable in the short term, but at some point rates will rise and deficits and debt will need to be resolved through spending cuts or tax increases,” wrote market strategist Meera Pandit. worldwide at JPMorgan Chase, in a January 2021 Remark.

Before the COVID-19 public health crisis, Fed Chairman Jerome Powell Told Congress that the national debt was on an “unsustainable” path.

“The U.S. federal government is on an unsustainable fiscal path,” Powell told the Senate Banking Committee in November 2019. “Debt as a percentage of GDP is rising, and is now rising sharply… And that’s unsustainable by definition. We need to stabilize debt to GDP. When to do it, the ways to do it — by revenue, by expense — all of those things are not up to the Fed to decide. »

In a webinar sponsored by the Economic Club of Washington, D.C., in April 2021, Powell Explain that the economy could bear the high debt burden. However, he warned that the long-term trajectory of the US budget is unsustainable.

Powell too Told Sen. John Kennedy (R-La.) earlier this year that the debt cannot grow faster than the national economy indefinitely.

But the central bank chairman noted that the US government should only tackle massive debt levels once the economy stabilizes.

According to the Congressional Budget Office (CBO), the federal debt is expected to reach 150% of gross domestic product (GDP) within 30 years. The budget watchdog has warned that if policymakers refuse to act, soaring debt will weigh on long-term economic growth, impede crucial investment, accelerate a budget crisis and prevent officials from reacting. to unforeseen events.

“The benefits of faster deficit reduction include smaller accumulated debt, fewer policy changes needed to achieve long-term results, and less uncertainty about what policies lawmakers would adopt,” the CBO said. . wrote in its long-term budgetary outlook for 2022.

What about the wider economy?

Since the start of the Fed’s tightening cycle last spring, money supply growth has remained flat. But has the damage already been done to the American economy?

NYSE Stock
Traders on the floor of the New York Stock Exchange watch a screen showing Federal Reserve Chairman Jerome Powell’s press conference following the Federal Reserve’s interest rate announcement, July 31, 2019. (Brendan McDermid/Reuters)

The annual inflation rate of 8.5% is the highest in 40 years. The producer price index (PPI) is still near levels not seen since the 2008-2009 financial crisis. The increase in the cost of living leads consumers to transform their buying habits, moving from consuming less to changing their demand patterns.

Many economists note that the labor market has been fractured: real wage growth is still in negative territory, productivity is falling, the number of quits remains high, job vacancies continue to be above 10 million and 7 .5 million Americans work two jobs.

Asset bubbles were the next notable consequence of the Fed’s historic monetary expansion. From stocks to cryptocurrencies, these assets hit all-time highs before crashing into a bear market. It is uncertain if the latest gains were part of a bear market rally or if the bottom was hit and a bull cycle started. But the equities arena is clinging to every word of the Federal Reserve, be it Chairman Powell or Fed Bank of St. Louis President James Bullard.

The consensus on Wall Street is that the US economy will sink into a sharp or moderate economic slowdown. if it hasn’t already been done. The country has slipped into a technical recession after two consecutive quarters of negative GDP growth. If economic conditions deteriorate, the Fed is expected to reverse its hawkish tightening campaign and begin to lower interest rates.

Fed officials said that was not happening. Instead, they say the institution will likely raise rates and leave them there, until there is concrete evidence that inflation is coming down significantly.

What’s next for the Fed?

Will the current monetary system remain intact or will it be overhauled?

Many developments are unfolding that could have long-term consequences for households, policymakers, and geopolitical activities.

Countries participate in a dedollarization initiative. The Fed is evaluating a central bank digital currency. Rising inflation and rising borrowing costs are weighing on consumers. Trust in the Federal Reserve has eroded considerably over the past two years.

Whether or not central bankers have pressed the monetary system reset button remains to be seen. But the pandemic might have ushered in a new era for economics and fiscal and monetary policy, one that Powell’s successor could facilitate and install into the fabric of the Federal Reserve’s infrastructure.

Andre Moran


Andrew Moran covers business, economics and finance. He was a writer and journalist for over a decade in Toronto, with bylines on Liberty Nation, Digital Journal and Career Addict. He is also the author of “The War on Cash”.