Is The Fed Fighting The Last War?

| About: ProShares Inflation (RINF)

Originally published November 21, 2016

Generals are often criticized for fighting the last war. One has to wonder whether the same criticism should not be leveled at the Federal Reserve today, as its senior officials now seem to be supporting Donald Trump's fiscal stimulus proposals. While fiscal stimulus might have been very helpful to the Fed in its efforts to revitalize the US economy in the aftermath of the Great Recession, the same is not true today as the US economy approaches full employment and as there are increasing signs of incipient wage inflation.

When the US economy was recovering from the Great Recession, the Fed could have benefited from an expansionary fiscal policy stance. Had it received such fiscal support, the Fed would not have been "the only game in town" to revitalize the ailing US economy. In particular, the Fed would not have needed to resort to unorthodox monetary policy on anything like the scale it felt forced to do, which expanded its balance sheet from US$800 billion in 2008 to US$ 4 ½ trillion by 2014. Nor would the Fed have felt forced to create the large asset bubbles that it has created through excessive money printing particularly in the US bond markets.

Today, as the US economy is at or very close to full employment, and as inflationary pressures are beginning to manifest themselves, the US needs a more restrictive macroeconomic policy stance to deal with today's US economic conjuncture. To that end, the last thing that the Fed now needs is an expansionary fiscal policy that would put more than the full burden of containing inflationary pressures on the Fed. Rather, one would have thought that the Fed's efforts in normalizing policies would have benefited from a restrictive rather than from an expansionary fiscal policy stance.

There are at least reasons that one would hope for a better balance between monetary and fiscal policy than the incoming Trump administration seems to be suggesting. The first is that if an undue burden is placed on the Fed to tighten policies, there is the risk that higher interest rates than would otherwise be required will cause a disruptive bursting of the asset bubbles that the Fed has created. The second is that higher interest rates would likely cause the US dollar to keep appreciating, which is bound to increase pressure on the new Trump administration to adopt a protectionist trade policy. That in turn could risk escalating into a global trade war.

About this article:

Tagged: , , Expert Insight, Market News Article
Problem with this article? Please tell us. Disagree with this article? .