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February 9, 2023

Is everything the Fed’s fault?

The Financial Times’ Robert Armstrong‘s latest story covers the Federal Reserve and its role in our current economic situation. He references the work of Better Markets and its recent report on the Federal Reserve and systematic instability. Below is an excerpt from the piece:

It is useful, then, when the case against the Fed is framed intelligently by a very reputable voice. Dennis Kelleher and Phillip Basil, of Better Markets, did just that in a report last month, “Federal Reserve Policies and Systemic Instability.” I encourage everyone to read it, if only to crystallise views about Fed policy works. A brief summary of the arguments:

  • Since 2008, Fed rate and balance sheet policy has decoupled asset prices from risk, and encouraged both companies and households to use a dangerous amount of debt. Very low rates mean investors have been “strongly incentivised if not forced into riskier assets, leading to mispriced risk and a build-up of debt”
  • Comparing the decade after the great financial crisis to the decade before, the growth in US debt held by the public was nearly 500 per cent larger, the growth in nonfinancial corporate loans and debt securities was about 90 per cent larger, and the growth in consumer credit — excluding mortgages — was roughly 30 per cent larger.
  • Proof that the central bank had pushed too much liquidity into the market with quantitative easing can be found in the Fed’s own reverse repo operations. “The Fed was pumping trillions of dollars into financial markets and limiting the supply of safe assets on one side of the market and siphoning out trillions of dollars from financial markets through its RRP facility on the other side.”
  • All this created a market excessively dependent on easy money, as the 2013 taper tantrum and the Fed being forced to ease policy in mid-2019 demonstrate.
  • Reversing these bad policies in the face of inflation risks recession, corporate defaults, stress in the Treasury market, and a cracked housing market. The Fed may overreact to these stresses, too — perpetuating the cycle of error.

You can read the full article here:




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