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The Fed Panicked, And Its Rate Cut Is Making The Economy Worse

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Mises Institute


  • Less than a week ago, several members of the Federal Reserve board reiterated - rightly so - that cutting rates would not have a significant impact in a supply shock like the current one.
  • A supply shock is not solved with demand-side policies.
  • The absolute imprudence and irresponsibility of maintaining ultra-expansive policies and deficit spending in a growth period come to bite now.

By Daniel Lacalle

The Federal Reserve's monumental mistake of cutting rates this past week can only be understood in the context of the rising God complex among central planners: an overwhelming combination of ignorance and arrogance.

Less than a week ago, several members of the Federal Reserve board reiterated - rightly so - that cutting rates would not have a significant impact in a supply shock like the current one. We must also remember that the Federal Reserve already cut rates in 2019 and inflated its balance sheet by 14 percent to almost all-time highs in recent months, completely reversing the virtually nonexistent prior normalization. Only a few days after making calls for prudence, the Fed launched an unnecessary and panic-inducing emergency rate cut and caused the opposite effect of what they desired. Instead of calming markets, the Federal Reserve's 50-basis point cut sent a message of panic to market participants.

If the jobs and manufacturing figures are better than expected, and the economy is solid, with low unemployment, what message does the Fed's emergency cut transmit? It tells market participants that the situation is much worse than it seems and that the Fed knows more than the rest of us about how dire everything can be. It is a communication and policy mistake driven by an incorrect diagnosis: the idea that the market crash would be solved with easy monetary policy instead of understanding the impact on stocks and growth of an evident supply shock due to the coronavirus epidemic.

There is no lack of monetary stimulus in the economy. Global money supply has soared to $81 trillion, an all-time high, in the middle of the epidemic, most leading economies have cut rates and implemented zero and negative real rates. In fact, major central banks were already injecting more than $150 billion a month (PBOC, ECB, Fed, etc.) into a doped economy

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The Mises Institute is the world’s largest, oldest, and most influential educational institution devoted to promoting Austrian economics, freedom, and peace in the tradition of classical liberalism. Since 1982, the Mises Institute has provided both scholars and laymen with resources to broaden their understanding of the economic school of thought known as Austrian economics. This school is most closely associated with our namesake, economist Ludwig von Mises.We are the worldwide epicenter of the Austrian movement. Through their research in the fields of economics, history, philosophy, and political theory, Mises’s students F.A. Hayek, Henry Hazlitt, Murray Rothbard, and others carried the Austrian School into the late twentieth century. Today, Mises Institute scholars and researchers continue the important work of the Austrian School.Austrian economics is a method of economic analysis, and is non-ideological. Nonetheless, the Austrian School has long been associated with libertarian and classical-liberal thought—promoting private property and freedom, while opposing war and aggression of all kinds. The Mises Institute continues to support research and education in this radical pro-freedom tradition of historians, philosophers, economists, and theorists such as Jean-Baptiste Say, Frédéric Bastiat, Richard Cobden, Herbert Spencer, Lysander Spooner, William Graham Sumner, Albert Jay Nock, Mises, Hayek, Hazlitt, Rothbard, and many others.

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Comments (21)

Wilbur76 profile picture
Fabulous article...but, stop making so much common sense! How will we get investors to BUY! BUY! BUY! when you explain why they shouldn't be jumping on a band-wagon that's heading for a big cliff?
Maga infinity profile picture
@Wilbur76 can we ask the congress to take over the 401k plans? Once that's done, it becomes an auto deductible from the payroll. Keep buying
So given all that you mention, and given that its not politicians that are reading your post, and given your ability to influence multi-nation monetary policy is probably pretty low (sorry:) what should a long-term investor invest in?
Maga infinity profile picture
I thought Fed have killed the virus with last week's cut. Am I wrong?
KURTKAMM profile picture
"Of course, there are measures that can be taken to reduce the impact of the coronavirus....."

Tell that to the moron in the Whitehouse.
MMT would say otherwise. The Fed's responsibility is to enable the Treasury to fill the banks' coffers so they can lend it. Federal government spending injects new reserves into the commercial banking system and taxation reduces reserves from the banking system. Through fiscal action--spending on projects and cutting taxes--reserves are added to the banking system which leads to a system-wide surplus of reserves and then competition between banks seeking to lend their excess reserves. This drives the short-term interest rates down to the Fed's support rate (or to zero or below). If the support rate the Fed is aiming for is too high, banks will simply keep their reserve surplus with the Fed and earn the support rate.

So in anticipation of fiscal stimulus, the Fed has to get out in front and drive the support rate down so that banks will lend the injection of new reserves to businesses and consumers and thereby avert or mitigate the supply and demand shocks we're experiencing now. This is why there are calls to cut the Fed Funds rate more, and even go negative.

This is also why there are more and more calls to do another massive tax cut. And that is totally affordable as MMT has shown that such spending and tax cutting is not harmful to the economy. We're starting to realize that Milton Friedman wasn't correct, the Phillips curve is not correct, crowding-out theory is not correct, etc. It is not "different this time". But rather, "we've been doing this all wrong, and it has led to a number of boom-bust cycles that needn't have ever occurred."

The big change is that we need to coordinate fiscal and monetary policy very tightly. An independent Fed is actually a big problem in this theory. MMT theorists will tell you that it was Bernanke's independence that really caused the Great Recession. Sure there were ill-advised financing shenanigans going on, but the Fed's response to the emerging crisis - not coordinated with the fiscal efforts begun by the Bush administration - caused the massive financial crisis, which then trickled out in the overall economy and caused the recession.
7281491: "The Fed's responsibility is to enable the Treasury to fill the banks' coffers so they can lend it."

I don't know which country you live in, but the Fed has no mandate to do that: it must maintain stable prices and and as full employment as it can influence. That's all.
7281491: "The big change is that we need to coordinate fiscal and monetary policy very tightly. An independent Fed is actually a big problem in this theory."

Of course it is: socialism was always about complete coordination of everything in sight --- and individual liberties be damned.
Maga infinity profile picture
@MarketsToday Fed has another mandate now: to cure the virus. This is more important than the other two mandates.
You are behind the curve, you are thinking like it's 2 weeks ago. This is not just supply shock, this is a demand shock too, the global economy is sinking to recession.
David de los Ángeles Buendía profile picture
Hello @xpan ,

Just so. People are not spending, workers do not go to work, businesses lose sales and income from customers who fear to buy and have less money to do so. Demand is indeed collapsing.

However the author is still correct, lowering interest rates will have no impact on that either.
David de los Ángeles Buendía: "lowering interest rates will have no impact on that either."

Of course it will: the demand will be larger than without the rate decrease but likely still lower than before.
David de los Ángeles Buendía profile picture
Hello @MarketsToday ,

Demand for food, petrol, housing, &c are not purchased with bank credit. People without jobs and companies without customers spend just as much on the essentials whether the Four Week United States Treasury Bill is paying 120 basis points or 150.
Nice article my Austrian friend. However, I think when you attribute their rate cutting policy mistake (with which I wholeheartedly agree) to 'ignorance and arrogance', you omit the very important factor of political pressure from elected officials whose time horizon only extends until the next election
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