The financial media is abuzz with speculation about what the Fed will do next, and whether it will decide to hike the federal funds rate target at its April Federal Open Market Committee (FOMC) meeting. There is a lot of speculation too as to what the Fed might do in the event of another recession or financial crisis. Some recent articles at the Brookings Institution delve into that possibility. And what is the first potential policy action discussed? Negative interest rates.
Just when you thought central banks couldn’t get any nuttier, the European Central Bank (ECB) has gone and done it. One of the ECB’s new programs may actually pay banks to borrow from it. Take away all the accounting sleights of hands and the net result would be an outright payment to those banks. It’s a direct subsidy, so why all the subterfuge? Just set up a direct pay-for-loan system, the more the banks loan the more the ECB pays them. That’s what most likely will happen eventually. It would be much simpler and much more honest, which is probably why they’re not doing it right now.
One of the problems with central banks acting as a lender of last resort is that of moral hazard. With the cost of bailouts spread out across society and benefits concentrated to a few large firms, the temptation to engage in excessively risky behavior is ever-present. Financial firms have become so used to getting their way from the government that they assume the Fed will bail them out of every difficult spot that comes along. The Federal Reserve’s monetary policy of the past eight years has been one huge bailout, funneling trillions of dollars of easy money to Wall Street, boosting stock prices, and creating bubbles throughout the economy. This loose monetary policy has led to such malinvestment that the economy will definitely fall into a recession or depression once the Fed takes away the punch bowl. Stock markets realize that the economy’s fundamentals are unsound, that firms are reliant on cheap central bank money for their continued performance, so the specter of Federal Reserve rate hikes and monetary policy normalization is leading to panic.
If you hoped that monetary policy would ever return to normal, you’re in for some disappointment. It appears as though central banks are hell-bent on doubling down on their mistakes. The past century has demonstrated time and again (Germany, Yugoslavia, Zimbabwe) the destructiveness of creating money out of thin air. Yet central banks continue with their money printing, going to greater and greater lengths and unveiling new tools and policies to try to stimulate their economies. It’s been so long now since monetary policy was “normal” that we’re into a new normal: permanent easing.
The years during and after the financial crisis saw a consensus of monetary easing among central bankers around the world. The Federal Reserve, the Bank of England, the European Central Bank, and the Bank of Japan all engaged in loosening their monetary policy, creating trillions of dollars worth of new money in an attempt to boost their economies. None of them wanted to be the only one not easing monetary policy, and none of them wanted to the first to return to “tighter” monetary policy. But are we beginning to see this easing consensus breaking down?
The Federal Reserve last week announced that it transferred $97.7 billion of its estimated 2015 net income to the US Treasury department, a new record. There are undoubtedly some people out there who see this as a great thing and wonder why we want to end the Federal Reserve System when the Fed gives the government so much money. You have to dig a little deeper and understand where that money is coming from to figure out what its effects are and why this is problematic.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
At $4.5 trillion, the Fed’s balance sheet is equivalent to about 27% of US GDP, over one quarter of the entire economic output of the United States. But it’s one thing to say that and read about it and another thing to put it into perspective.