The Fed Just Lost Control
The Fed Just Lost Control by Olav Dirkmaat for Gold Republic
Do you remember? That darn “quantitative easing?” According to naïve gold bugs, this expansion of central bank liabilities (dollar bills and commercial bank deposits at the central bank) would lead to hyperinflation. By the way, whenever you hear the term “monetary base” (M.B.), then this term refers to the amount of central bank liabilities. This week I met the former chairman of the Federal Reserve in Cleveland, the creator of the monetary base as statistic, and he showed me why the Federal Reserve has just lost control over its monetary policy.
This Was “Quantitative Easing” in the U.S.
“Quantitative easing”, or QE, began in the U.S. shortly after the 2008 crisis. Since interest rates were already lowered until zero, the Fed-chairman at the time, Ben Bernanke, moved to a more extreme measure. QE consisted of purchases of long-dated U.S. Treasuries (sovereign debt) and mortgage backed securities (MBS; a bunch of illiquid mortgages turned into a security) for a fixed amount and a fixed duration. The Federal Reserve also began to pay interest on deposits that central banks held at the Fed, something completely new in U.S. monetary policy.
The result was the famous “hockey stick”-chart, in which the monetary base rose a few hundred percent. For many, this was the moment to declare that we were on the verge of hyperinflation, Zimbabwe style.
What Are the Consequences of QE for Monetary Policy?
The problem, however, is that ever since QE the objectives and indicators that the central bank use no longer work. They no longer provide the information that policy makers require to make the right decisions. Let us look at a few concrete examples of the negative consequences of QE:
- QE increased the monetary base manifold, primarily by creating deposits that commercial banks hold at the central bank. These deposits are “reserves” for commercial banks. These banks, thanks to QE, are now sitting on a huge pile of “excess reserves” or, in other words, much more bank reserves than the minimum level banks are required to hold.