Wednesday, August 10, 2005
Fed Monetary Policy: Accomodative or Restrictive?
The Fed's Report to Congress on July 20 and the FOMC statement of August 9, 2005 indicate that the "The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity."
This belief deserves questioning in light of the fact that the rate of growth of the monetary aggregates have declined substantially since the Fed began its tightening in June 2004. For example the growth of the Adjusted Monetary Base (banking system reserves and currency outside banks, Fed and Treasury) has slowed from 5.5 percent in June 2004 to 3.3 percent in late July and early August 2005. Additionally, the broader measure of money, M2, has slowed to 3.4 percent. With the growth of nominal GDP projected by the Fed to be between 5 percent and 6.25 percent for the second-half of 2005, growth of the monetary aggregates are clearly not keeping pace. A less accommodative monetary policy regime over this same period can only mean that the growth in the monetary aggregates will continue to slow.
The evidence suggests that the Fed may have reached a point, or is rapidly getting there, when the stance of monetary policy is no longer accommodative. An increasing ratio of nominal GDP to M2 (M2 velocity) is not sustainable without upward pressure on interest rates due to a substantial debt buildup to maintain expenditure levels that is the source of the pressure on interest rates to rise.
The source of the inflationary pressures the Fed alludes to in the FOMC meeting release is identified in the Fed's Report to Congress as oil prices. If the inflation of the price of a single commodity is the sole source of inflationary pressures in the U.S., is monetary policy the most effective tool to combat general inflation of all goods and services caused by a single commodity?
First, even by the Fed's own admission, the price inflation of most other goods does seem to be modest. From this perspective, what's the problem? Secondly, the use of oil products will be curtailed if the price of oil continues to rise and other goods will be substituted for it in production and consumption. This is the way of competitive markets and the Fed can do nothing about the price of oil or substitution short of causing an economic slowdown or recession.
In short, the Fed should consider slowing its restrictive monetary policy that it has pursued for 15 months and try not to fight inflationary pressures that are the result of a single commodity and not the excessive growth of aggregate demand. --GAHSr
This belief deserves questioning in light of the fact that the rate of growth of the monetary aggregates have declined substantially since the Fed began its tightening in June 2004. For example the growth of the Adjusted Monetary Base (banking system reserves and currency outside banks, Fed and Treasury) has slowed from 5.5 percent in June 2004 to 3.3 percent in late July and early August 2005. Additionally, the broader measure of money, M2, has slowed to 3.4 percent. With the growth of nominal GDP projected by the Fed to be between 5 percent and 6.25 percent for the second-half of 2005, growth of the monetary aggregates are clearly not keeping pace. A less accommodative monetary policy regime over this same period can only mean that the growth in the monetary aggregates will continue to slow.
The evidence suggests that the Fed may have reached a point, or is rapidly getting there, when the stance of monetary policy is no longer accommodative. An increasing ratio of nominal GDP to M2 (M2 velocity) is not sustainable without upward pressure on interest rates due to a substantial debt buildup to maintain expenditure levels that is the source of the pressure on interest rates to rise.
The source of the inflationary pressures the Fed alludes to in the FOMC meeting release is identified in the Fed's Report to Congress as oil prices. If the inflation of the price of a single commodity is the sole source of inflationary pressures in the U.S., is monetary policy the most effective tool to combat general inflation of all goods and services caused by a single commodity?
First, even by the Fed's own admission, the price inflation of most other goods does seem to be modest. From this perspective, what's the problem? Secondly, the use of oil products will be curtailed if the price of oil continues to rise and other goods will be substituted for it in production and consumption. This is the way of competitive markets and the Fed can do nothing about the price of oil or substitution short of causing an economic slowdown or recession.
In short, the Fed should consider slowing its restrictive monetary policy that it has pursued for 15 months and try not to fight inflationary pressures that are the result of a single commodity and not the excessive growth of aggregate demand. --GAHSr
