Kicking Over My Traces

I’m a week late checking up on the money supply as tracked by the St. Louis Federal Reserve:

If you compare this graph to the graph that I posted last month, you’ll see that the sky rocket has poked another hole in the clouds, punching right through $2.0 trillion without a hitch in its git-along.

Where is most of that money stashed?

Richard W. Fisher, president and CEO of the Federal Reserve Bank of Dallas, speaking to the Austin Headliners Club, said that a lot of banks are keeping a lot of money parked with the Federal Reserve to repair their capital reserves — but at some point that money will break free and the Federal Reserve will need to consider how to tighten monetary policy to ease the sky rocket down without blowing the economy to Kingdom Come.

Here is what Mr. Fisher had to say on the topic of tightening:

The press and the markets are eager to know when we might undertake a tightening in policy. The answer to this question is … “It depends.” Our mandate is to pursue the maximum level of employment consistent with long-term price stability. So, when and how rapidly we reduce our accommodative policy must depend on fine judgments about how quickly the real economy gets back on track without jeopardizing our longer-run price-stability goal. As noted in our most recent statement, the FOMC will consider a variety of economic indicators—including resource slack, inflation trends and inflation expectations—when making this decision. But for the foreseeable future, the FOMC considers policy to be appropriately calibrated to the times.

My own judgment—based partly on available estimates of slack, but also on the behavior of prices, and informed by the anecdotal input I receive monthly from business leaders as to their intentions—is that inflation is likely to remain subdued for some time, and thus our current policy is appropriate. Of course, I recognize that our measures of slack and our understanding of the determinants of inflation are uncertain. And agile business leaders can change plans on a dime. Being what some believe to be the most hawkish member of the FOMC, I am very Reagan-esque in my evaluation of inflationary potential: I trust but continually seek to verify that inflation is not raising its ugly head. So, as I’ve always done, I will keep a close eye on price developments as they unfold.

Right now, I see more immediate deflationary pressures than inflationary ones. Yet I am fully aware that the law of unintended consequences is always lurking in the shadows. For instance, having spent a few years early in my banking career as a foreign exchange advisor to investors and corporations, I am particularly mindful of the risks we run by stating in FOMC statements that we expect to maintain the Fed funds rate at “exceptionally low levels” for “an extended period.” This could fuel the “carry” trade, whereby speculators—assuming U.S. rates will remain unchanged over a reasonable time horizon—can borrow plentiful amounts of dollars cheaply and invest them in securities denominated in other currencies that yield more or offer greater returns, in the process driving those securities and currencies to prices beyond their equilibrium levels. Were this to become a disorderly influence, I would expect the FOMC and other authorities to craft an appropriate remedy.

Mr. Fisher’s thumbnail economic forecast: “looking into 2010 and perhaps to 2011, the most likely outcome is for growth to be suboptimal, unemployment to remain a vexing problem and inflation to remain subdued.”

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Tags: Business, Economic, economics, Federal Open Market Committee, Federal Reserve System, monetary policy, money supply, Politics

This entry was posted on Wednesday, November 11th, 2009 at 2:08 pm +0000 GMT and is filed under Business, Politics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.