On January 25, 2012, The Federal Reserve (aka “the Fed”) issued a press release that undoubtedly provided financial markets a spark, but provided (or should have provided) the exact opposite reaction from others. The Federal Open Markets Committee (FOMC) unveiled its plan to maintain the federal funds rate at historic low rate (i.e., practically zero) through the end of 2014. Previously, the Fed anticipated this rate to continue through mid-2013. The more than one year extension promise of easy money rallied stocks, commodities and Treasuries at the same time that the value of the dollar fell. However, forecasting the maintenance of these historical low rates for such a long period of time signals that the Fed believes that the “recovery” is weak and will continue to be weak for an unprecedented amount of time (in U.S. history).
According to the Fed’s press release:
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. [emphasis added]
Recall that the Fed initially reacted to the economic downturn by lowering short-term interest rates to exceptional near zero rates, followed by launching multiple experimental and controversial Quantitative Easing (QE1, QE2 – buying its own debt) to stimulate the economy. Many believe QE3 is on the way. With little economic response from these two monetary policies, the Fed recently started and continues “Operation Twist”, a program designed to lengthen the maturity of the Fed’s holdings to further stimulate growth. Given the Fed’s current economic predictions, all three of these policies have been at best less than fruitful.
Last summer, in Chairman Bernanke’s first ever press conference, he claimed that these recent monetary policies (e.g., near zero rates, QE) are “not that different than ordinary monetary policy”. However, the Fed’s own data appears to disagree. The following four charts provided by the Fed show that we are in unchartered territory with these policies. Many referred to the “pessimists” that have been predicting that the recent U.S. economy is the next “Japan’s lost decade” as engaging in “crazy talk”. Well, it seems the Fed now agrees with that so-called “crazy talk”.
Note that in all of the following four charts, the shaded areas indicate U.S. recessions.
1. Recent U.S. government interest rates continue to be at near zero, which is clearly abnormal.
2. Growth in the money supply has always led to higher inflation. Nothing has occurred in economics to indicate that this maxim no longer applies. Because of the Fed’s multiple QE programs, the increase in the monetary base (the amount of money in the economy) is unprecedented.
3. Banks continue to hold unprecedented amounts of the excess reserves, rather than loaning it. Much (but not all) of these excess reserves come from the increased money supply.
4. The large amount of held money decreases the velocity of money stock. Money velocity refers to how quickly a dollar changes hands – for example, when you deposit a dollar into your checking or savings account, your bank can then lend that dollar out to ten other people, essentially creating ten more dollars out of your one dollar deposit. Today’s low velocity in chart 4 below is a way of examining the impact of the data in Chart 3 above.