It's The Economy Stupid: Fed Doing More Harm Than Good???

Two recently published pieces (both drawing on the same academic research) suggesting that the Fed’s economic support of the economy has reached its limits and may actually being doing more harm than good.

 

Summary:

 

Scholarly studies published in the past three years document that economic growth slows when public and private debt exceeds 260% to 275% of GDP.  In the U.S., from 1870 until the late 1990s, real GDP grew by 3.7% per annum. It was during 2000 that total debt breached the 260% level.  Since 2000 GDP growth has averaged a much slower 1.8% per annum.  Meanwhile the Fed’s balance sheet has exploded in size, greatly increasing combined public and private debt even though private balance sheets have been deleveraging.

 

When an economy is excessively over-indebted and disinflationary factors force central banks to cut overnight interest rates to as close to zero as possible, central bank policy is powerless to further move inflation or growth metrics.

 

Four considerations suggest the Fed will continue to be unsuccessful in engineering increasing growth and higher inflation with their continuation of the current program of Large Scale Asset Purchases (LSAP):

 

·         First, the Fed's forecasts have consistently been too optimistic, which indicates that their knowledge of how LSAP operates is flawed. LSAP obviously is not working in the way they had hoped, and they are unable to make needed course corrections.

·         Second, debt levels in the U.S. are so excessive that monetary policy's traditional transmission mechanism is broken.

·         Third, recent scholarly studies, all employing different rigorous analytical methods, indicate LSAP is ineffective.

·         Fourth, the velocity of money has slumped, and that trend will continue—which deprives the Fed of the ability to have a measurable influence on aggregate economic activity and is an alternative way of confirming the validity of the aforementioned academic studies.

 

 

John Broussard

Assistant State Treasurer

Chief Investment Officer

State of Louisiana

Department of the Treasury

225-342-0013

jbroussard@treasury.state.la.us