Taps Coogan – October 1st, 2022

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As we often note, one of our first bailiwicks here at The Sounding Line was pointing out the implications of the ‘Excess Reserves’ monetary policy regime that emerged after the Global Financial Crisis (GFC) and the perverse incentives that the Fed’s policy of paying interest on reserves has created.

Along those lines, Dr. Judy Shelton, controversial former Fed Board Nominee, Senior Fellow at the Independent Institute, and frequent critic of the Fed’s excess reserve regime, recently spoke with CNBC’s Joe Kernen.

 

Some excerpts from Judy Shelton:

“I don’t think what Chairman Powell is doing is similar to what Paul Volcker did. Paul Volcker was really targeting the money supply. He let interest rates… go wherever they need to go. In 1980, the FOMC directive said that the Federal Funds target would be between 8%-14%, the point being the Fed was selling off its securities to move the interest rate (Taps: and not targeting a specific number). This Fed is doing something very different. They are paying a record high interest rate on a record high pile of cash kept at the Fed, effectively bribing commercial banks and money market funds to keep that money from doing anything productive, keep it in cash in a risk free government guaranteed account receiving over 3% (interest) now, maybe 4.5% by the end of the year. As little sense as it makes to pay people not to work. Now our central bank is paying banks not to lend…”

“The problem with the way the Fed sets interest rates, which is paying money on cash, is we really don’t know what the real cost of capital should be. It’s artificially established and all we know is that the Fed thinks it should be ‘restrictive.’ …Where is the logic? At a time when we are trying to increase supply to soak up demand, the Fed’s strategy is to slow down economic growth and at a time when we are finally coaxing people back to work the Fed’s strategy is to increase unemployment… I think we will look back at this era of central banking the same way we look at medieval medicine where doctors would help get rid of a sickness by bleeding the patient.”

We could not agree more strongly. The excess reserve regime and the administration of rates on an overnight market that no longer serves a priced-discovery function, is the monetary policy issue of our era. 

The Fed needs to stop hiking or lowering rates, but instead widen the trading band while reducing its balance sheet and withdrawing the interest on excess reserves. That’s the way to a sane monetary regime. 

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