On 21 March 2022, Jerome Powell, chairman pro tempore of the Board of Governors of the Federal Reserve, made comments about labor markets, inflation, and reduction in the balance sheet of the Federal Reserve System. Mr Powell acknowledged that the labor market is tight and that nominal wages are rising, particularly at the lower end of the wage distribution. Given what he noted as the severe imbalance of supply and demand in the labor market, Mr Powell wants to use the Federal Reserve System’s monetary policy tools to moderate the growth in demand for labor.
Analysts and investors have been raising concerns about the Federal Reserve’s balance sheet. Mr Powell noted in his comments that reducing the Federal Reserve System’s balance sheet could bring inflation to near two percent over the next three years.
The economy, according to Mr Powell, is in a position to handle tighter monetary policy and he stated his willingness to see the interbank overnight (fed funds) rate increase by more than 25 basis points at the next Federal Open Market Committee meeting.
I appreciate the hawkishness for one reason. It pushes back on the desire by political factions to weaponize the fed funds rate. The effective fed funds rate, a volume-weighted median of transactions level data collected from banks, has increased over four times from its long-term rate of .08% to a current 0.33%. The fed funds rate is the overnight rate that banks charge each other for lending and borrowing excess reserves. The rate sits near the middle of the .25% to .50% range recommended by the FOMC.
On its face, the recent effective funds rate may incentivize banks to seek returns from the interbank market versus purchasing Treasurys. For example, the yield per day on a one-year Treasury bill is .00442% versus an overnight fed funds rate of 0.33%. Putting those excess reserves into the bond market would call for much higher yields which in turn would call for a fall in asset prices and clamping down on the rise in prices.
The Federal Reserve System has at its disposal a number of monetary policy tools to nudge banks to the overnight trading range including open market operations; the discount window and discount rate; reserve requirements; interest on reserves; reverse repurchase agreements; and liquidity swaps, to name a few.
Even with its tools and noble statutory mandate of pursuing stable prices and full employment, the Federal Reserve System still represents Congress’ abdication of its responsibility for coining money and regulating its value. Yes, Congress can authorize the mechanisms it deems necessary for meeting this statutory duty, but where the taxpayer/consumer/electorate is seeing an erosion of her spending and saving power, might it be time for Congress to reassert its statutory duty versus allowing the Federal Reserve System to act as a coordinator of bank cartel activity?
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