{"id":348,"date":"2010-02-10T13:38:00","date_gmt":"2010-02-10T18:38:00","guid":{"rendered":"http:\/\/www.intuitiveinvestor.com\/web\/?p=348"},"modified":"2018-08-21T09:16:42","modified_gmt":"2018-08-21T13:16:42","slug":"the-fed-chairman-addresses-how-to-deal-with-inflation","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2010\/02\/10\/the-fed-chairman-addresses-how-to-deal-with-inflation\/","title":{"rendered":"The Fed Chairman addresses how to deal with inflation"},"content":{"rendered":"

There are two major levers for economies around the world.\u00a0 The first is fiscal policy.\u00a0 That is, the collection of budgetary, taxation and legal choices made by the legislatures of the world’s nations.\u00a0 The second is monetary policy.\u00a0 That is, the interest rate and money supply choices made by the central banks of the world.\u00a0 Within that framework, I would argue that this most recent recession had two primary structural causes, one fiscal and the other monetary.<\/span><\/p>\n

The first was the choice made by a business-beholden Congress to repeal many of the Great Depression-era laws that economically protected the U.S. for nearly three generations.\u00a0 This is categorized as a fiscal policy mistake as the U.S. Congress is directly in control of budgetary, taxation and legal choices.<\/span><\/p>\n

The second primary cause was the Federal Reserve’s choice after the recession of 2001 to leave interest rates incredibly low for almost a decade.\u00a0 Any time you underprice an asset, in this case money itself, then that asset has excess demand and overuse.\u00a0 In other words, the air in the economic bubble was crazy low interest rates.\u00a0 This mistake is a monetary policy snafu as the Fed sets interest rate policy for the United States.\u00a0 Not only that, but it is the World’s de facto Central Bank.<\/span><\/p>\n

It’s only natural that many investors, myself included, are concerned about ensuring these two causes do not repeat themselves.\u00a0 While the renewing of protective legislation seems stalled out in Congress, the interest rate debate is raging on.\u00a0 To that effect, Federal Reserve Chairman,\u00a0Ben Bernanke, testified before Congress today to discuss how the Fed plans on dealing with interest rates once the U.S. economy is on sounder footing.<\/span><\/p>\n

Banks often park their excess cash reserves at the Federal Reserve.\u00a0 They not only do this to ensure that they can earn an interest rate on the reserves, but also to ensure the safety and liquidity of their principal.\u00a0 The Federal Reserve has been paying very, very low rates on these reserves.\u00a0 In effect that acts as an economic stimulus.\u00a0 The reason is that banks like to earn high risk-adjusted returns on their investments, just like all of us.\u00a0 So when the Fed pays a very low rate on reserves then banks have a greater incentive to find an alternative investment that pays a higher return; say mortgages, for example.\u00a0 Another example, would be lending to other financial institutions who are short in meeting reserve requirements.\u00a0 There are many such options.\u00a0 But if the Fed is concerned about inflation then it wants to take money out of the U.S. economy.\u00a0 One way of doing this is to raise the interest rates it pays to banks.\u00a0 In so doing, then the banks have an incentive to park more reserves at the Federal Reserve, thus taking excess funds out of the economy.<\/span><\/p>\n

While this sounds very dry, this is actually a radical departure in how the Federal Reserve implements monetary policy.\u00a0 Traditionally the Fed changed the “Fed Funds” interest rate.\u00a0 This is the rate that banks pay each other when they borrow from another bank.\u00a0 But during the recession banks stopped trusting one another.\u00a0 Thus, when a bank that needed to borrow money to meet minimum reserve requirements called a bank with excess reserves, more often than not, the bank in the more favorable position declined to lend money.\u00a0 Ouch!\u00a0 So the Fed stepped in as the lender of last resort.\u00a0 It is for this reason that the Fed has so dramatically changed how it implements monetary policy.<\/span><\/p>\n

While\u00a0Ben Bernanke discussed how he would<\/em> deal with inflation, he did not discuss when<\/em> he would deal with inflation.\u00a0 Nor did he state specific criteria to be looking for.\u00a0 This is disappointing.\u00a0 However, by not addressing the issue we can assume that Bernanke does not feel that the U.S. economy is on a\u00a0firm enough footing right now to justify a raise in interest rates.\u00a0 So the inflation fears remain.\u00a0 And, as an investor, the last thing I want to be dealing with right now is another fear hanging over the market.\u00a0 Ugh!<\/span><\/p>\n

Jason<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

There are two major levers for economies around the world.\u00a0 The first is fiscal policy.\u00a0 That is, the collection of budgetary, taxation and legal choices made by the legislatures of the world’s nations.\u00a0 The second is monetary policy.\u00a0 That is, the interest rate and money supply choices made by the central banks of the world.\u00a0 […]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3],"tags":[],"class_list":["post-348","post","type-post","status-publish","format-standard","hentry","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/348","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=348"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/348\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=348"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=348"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=348"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}