The Federal Reserve

 

The Federal Reserve gets a lot of attention but folks do not always discuss what all that it does and what it should do.

The general discussion is that the Federal Reserve has a dual-mandate: keep inflation low and keep unemployment low. This misses what the Fed really does.

The most important role of the Fed is its everyday role. It keeps safe the nation's banking and payment systems. It handles check processing and wire transfer systems. It is the banker for the Treasury Department. It acts as a potential lender for banks which are cash short each day. Those are the everyday things.

The most important non-everyday role of the Federal Reserve is its ability to do what it did when the post-Lehman liquidity crisis happened. Interbank lending stopped because no one trusted anyone else. The Fed's intervention with massive liquidity injection was, by far, the greatest single thing which saved us from a much worse recession. In my view, this ability to inject liquidity into the banking system when there is crisis is by far the most important thing the Fed does.

Another thing the Fed does is support the publishing of scholarly articles about the economy. Some find this discomforting because such a large percent of published work on the economy (about 75%) is underwritten by the Fed.

Getting back to the two stated goals of the Fed - unemployment and inflation - I have no idea if the Fed's QE's have really helped unemployment. There is a risk here which concerns me. This expansion of money supply is on a scale never before seen. Generally, expanded money supply risks inflation. The Fed is likely to find itself in the near future choosing between which of its two mandates it will prefer because it may have to reduce money supply to prevent inflation and, in doing so, hurt GDP and jobs.

There is one more point I would add. Other than pay attention to inflation and unemployment the Fed should constantly monitor the value of the US$ and intervene in Forex markets as necessary. If Congress is going to revise the Fed's goals it should add the stability of the US$. One has to believe that they, in fact, do this but it might benefit people if the Fed actually says this and if people realize that US$ stability is a prerequisite for a healthy economy.

Dodd-Frank and CFPB have also put the role of overseeing regulations in the hands of the Fed. As people object to the outcome of these regulations the Fed will take heat. What the results of that will be is something I cannot estimate.

 

Is the Supply Side Failing?

A question we should be seeking the answer to is "Why has economic growth been so puny lately?"

We had the Great Recession which was caused by the government's insistence that home loan lenders lower their lending standards so that more folks could afford to own a home. Banks and Wall Street went along because they made money by following the demand for relaxed lending standards. The result was the Great Recession.

 

The Federal Reserve provided the liquidity to save the banking system. Since then the Fed has increased monetary base by an enormous amount, kept interest rates at essentially zero but the results have only been spikes in commodities and, lately, equities. Economic growth (GDP) has been puny. Why?

 

Too much attention has been paid to the demand side. Bush II lowered taxes so that folks would have more to spend. The government has continued massive Keynesian spending but economic growth still is terrible.

 

Maybe we are looking in the wrong place. Maybe the fact is that real economic growth starts on the supply side.

What do I mean? Did Blackberry, iPhone, and iPad get created by demand or supply? What was the demand for PC's the day the Apple II or TRS 80 came out? What was the demand for the Internet before 1995? What was the demand for cellphones before there were cell phones? What was the demand for Tesla before there was Tesla? Were the Wright brothers responding to a demand for air travel? CDs, DVD's, iTunes, Facebook, search engines?

 

My point is that much of what consumers now spend money on are things which were not responses to demand. They were innovations on the supply side.

Unfortunately the words "supply side" have become ridiculously politicized and anything which become politicized is more difficult to discuss objectively. I am not talking only about taxes. I am merely making the observation that much recent growth has started on the supply side and we need to ask "what's wrong with the supply side."

One person who is presently creating supply-side innovative stimulus is Elon Musk.