In the past, I would do regular updates of the adjusted monetary base. This is a chart that the Federal Reserve directly controls. The monetary base shows us what the Fed is doing in terms of buying and selling assets.
What the monetary base does not tell us is price inflation. In fact, it doesn’t even give us a good picture of monetary inflation because it does not account for fractional reserve lending. Because much of the newly created money of the last 7 years went into bank reserves, it did not multiply through the system. This is one of the major reasons that price inflation has not been commensurate with the increase in base money.
As expected, the adjusted monetary base has been relatively flat since late 2014. The Fed is doing what it said it would do. Since the end of QE3 in late 2014, it has maintained an essentially neutral monetary policy in the sense that it is not buying or selling assets.
It is rolling over maturing debt, so the Fed is still buying in that sense. But its overall balance sheet is staying the same.
There are slight variations, which we will always see. Due to maturing debt and other possible factors, even a neutral policy will show minor ups and downs. But for the most part, the monetary base has been flat for the last 8 months.
We should expect this to continue until we hear anything different from the Fed.
I know all of the current talk is about interest rates. They say interest rates, but really it is just the federal funds rate. This is the overnight borrowing rate for banks, which has been near zero for nearly 7 years because the big commercial banks have massive piles of excess reserves. They don’t need overnight borrowing to meet reserve requirements.
The only feasible way the Fed can raise this rate is by paying a higher rate on bank reserves. This will not change the monetary base.
The bigger question at this point is what the Fed will do if we see another major economic downturn. We already saw a negative first quarter GDP. What happens if the second quarter is bad? What happens if we see a major stock market correction?
I don’t care that much about the federal funds rate except in so much as it affects investor sentiment. I care about when QE4 will arrive. That is when we will see the monetary base jump higher again. That is when I will be looking for the possibility of significantly higher price inflation.