FOMC Statement – July 30, 2014

The FOMC released its latest statement on monetary policy on July 30, 2014.  There were no major surprises.  The Fed will be reducing asset purchases by another $10 billion.  It will now be inflating by “only” $25 billion per month, which would have been unprecedented 6 years ago.

If everything goes as planned, it will announce another reduction in its purchases by another $10 billion in September.  In the meeting at the end of October, it should announce an end to the final $15 billion.

Again, this is only if everything goes as planned.  This means that we won’t see a major stock market crash or some other signal of a major economic downturn.

I am still not sure why most everyone is so focused on interest rates, which is really just the federal funds rate.  This is the overnight borrowing rate for banks.  It has been near zero since late 2008.

It made sense for people to obsess over this rate in the past.  That’s because it was an indication of monetary policy.  If the Fed wanted a lower federal funds rate, then it would usually have to inflate the money supply.  If it wanted to raise the rate, it would have to stop inflating, or maybe even contract the money supply.

But over the last 5 and a half years, the rate has meant little.  Commercial banks have piled up massive excess reserves and mostly do not require overnight borrowing to meet reserve requirements.  It hasn’t mattered whether the Fed has been inflating or not.  The rate has stayed near zero.

The Fed could certainly raise this rate if it really wants to.  It can increase the interest paid on excess reserves.  But this has no immediate effect on whether the Fed creates more monetary inflation.

Again, I don’t understand why people are obsessing over the federal funds rate.  This is not driving the monetary inflation.  We know what the monetary inflation is.  The FOMC statements tell us every time.  The Fed is now currently adding about $25 billion per month to the monetary base.

While the Fed is still inflating as of right now, I believe there is a much higher risk of a recession or major economic downturn.  The Austrian Business Cycle Theory teaches us that malinvestments can become exposed just by not increasing the rate of monetary inflation.  The misallocated resources certainly can become exposed when the rate of monetary inflation is decreasing, as it is now.  This can take some time, but if the Fed does not ramp up the digital printing presses again soon, then we will likely see a downturn in the economy.  The previous mistakes will be revealed.

Let’s see if the economy holds together long enough for Yellen and the Fed to complete its so-called tapering.

When things start to fall apart, I expect the Fed to taper its taper, if that makes sense.  I expect it will go back to more digital money printing.