ANTONI: The Fed Has Once Again Created An Easy Money Addiction, And Withdrawal Starts This Month


E.J. Antoni Contributor
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The Federal Reserve (Fed) seems intent on harming its patient, the U.S. economy.

On the heels of the highest consumer inflation in four decades, the U.S. Department of Labor’s producer-price index (PPI) shows that inflation is accelerating and the Fed has been downright negligent.

The PPI had its second highest increase in the history of the index, both in terms of month-over-month and year-over-year percent changes. These wholesale price increases will filter down to the retail level, putting more upward pressure on consumer prices in the coming months. This inflation is the symptom of the Fed’s excessively expansionist monetary policy over the last two years.

The government-imposed shutdowns in 2020 were like major surgery, after which a patient needs potent painkillers to make it through the following weeks. The Fed was happy to oblige, prescribing easy money as the opioid of choice for the economy. But instead of cutting off the supply in the wake of an early recovery, the Fed kept pushing the drug of cheap credit, and the patient got addicted.

Proof of that dependency is the myriad of economic reports that show inflation as a large portion of nominal economic growth. For the last three quarters, according to the U.S. Department of Commerce, nominal economic growth has been double real growth — with the difference being inflation.

Similarly, the Census Bureau’s monthly wholesale and retail trade surveys, as well as its manufacturing M3 survey, have repeatedly shown nominal growth near their respective inflation rates. Each of these surveys has also recently had months with nominal growth below inflation, yielding negative real growth rates.

Since monetary policy has long and variable lags, the time for the Fed to act was months ago. Yet it is still purchasing debt instruments, adding to its balance sheet, and furthering the easy-money addiction.

The housing market especially has fallen prey to this cheap-credit dependence in no small part to the Fed’s buying $1.3 trillion in mortgage-backed securities since March 2020. Just common sense tells us that massive purchases of a derivative will impact the price of the underlying asset. This was ignored by the Fed, who is still purchasing those derivatives today.

The Fed is not only aware of the problem but has been attempting to triage it as well. Almost a year ago, the Fed began using Reverse Repurchase Agreements (reverse repos) in earnest to soak up excess liquidity, borrowing cash on an overnight basis with securities serving as collateral. Instead of being a short-term measure, this has morphed into a longer-term strategy as the Fed attempts to square the circle of keeping nominal rates at zero while not causing inflation. These daily purchases by the Fed are hovering around $1.7 trillion.

That gives a rough estimate of how much liquidity the Fed needs to wring out of the system before any impact is felt on inflation. This also puts the Fed itself in an awkward position since its revenue comes from the long-term debt instruments on its balance sheet, but it is incurring mounting short-term expenses, since it must pay interest on its reverse repos. That is an increasingly precarious position for not just the patient, but the doctor as well.

While the central bankers pushed their low interest rates and cheap credit into the economy, they ignored the warning signs of growing dependency for an entire year. Now, as inflation barrels forward with all the momentum of a freight train, the Fed has no choice but to tighten credit. The patient will go through unpleasant withdrawal symptoms, likely in the form of anemic growth or even recession. If a medical doctor had done to a patient what the Fed has done to the economy, that doctor would be sued for malpractice and stripped of his or her license.

E.J. Antoni, Ph.D. is an economist at Texas Public Policy Foundation and a Senior Fellow at Committee to Unleash Prosperity.