The Fed is Impotent

by Ray Keating

The Keating Files – March 2, 2020

All sorts of talking heads and incessant Tweeters in politics and on Wall Street cry out for the Fed to act in the face of the spreading coronavirus. Specifically, they call for the Fed to cut interest rates (i.e., the federal funds rate) and do another round of quantitative easing (i.e., pumping more money out the door).

As markets have dropped due to uncertainty swirling around the coronavirus, it’s painfully ridiculous to assume that the Fed could do anything to make a difference. But politicians and many in the financial industry have bought into the mistaken assumption that the Fed is some kind of all-powerful entity when it comes to the economy. 

That most assuredly is not the case. In fact, the Fed has proven to be impotent for at least a dozen years now.

Consider that since the late summer 2008, the Fed has been running insanely loose monetary policy – so loose that is has no precedent in U.S. history – and yet we suffered through one of the worst, if not the worst, recession since the Great Depression, and a grossly underperforming recovery/expansion period since mid-2009.

For example, the Fed expanded the monetary base - that is, the sum of currency in circulation and reserve balances (deposits held by banks and other depository institutions in their accounts at the Federal Reserve) from $875 billion in August 2008 to $3.45 trillion in February 2020 (actually topping $4 trillion at points in 2014 and 2015). At the same time, excess bank reserves went from a mere $1.9 billion in August 2008 to $1.5 trillion in February 2020. Even with the Fed reining things in the monetary base a tad from September 2017 to September 2019, there remains no lack of liquidity. 

Meanwhile, real GDP growth has averaged a rather woeful 2.3 percent since mid-2009. That compares to average growth of 3.6 percent that prevailed from 1950 to 2007, and during recovery/expansion years over that period, the average had been 4.4 percent. That is, real economic growth has been running at nearly half of what it should since mid-2009.

Nonetheless, apologists will proclaim that the Fed somehow saved the U.S. economy during the 2008-09 mess and afterwards. In reality, the best that could be said about Fed monetary policy since 2008 is that it made no difference. More likely, such unprecedented looseness added to the uncertainty that contributed to sluggish growth.

And now the Fed’s minions are looking for a further loosening of monetary policy. Their answers, though, to questions as to how this would actually make a difference in the current situation remains, to be generous, elusive.

The Fed can do nothing positive while this unfortunate coronavirus scenario plays out – indeed, nor can the White House or Congress (other than accelerating the drug approval process for pharmaceutical companies). However, poor decisions certainly could create further negatives now and after the coronavirus fades away to become a grave and unfortunate memory.

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Ray Keating is a columnist, an economist, a novelist (his latest novels are The Traitor: A Pastor Stephen Grant Novel, which is the 12^thbook in the series, and the second edition of Root of All Evil? A Pastor Stephen Grant Novel with a new Author Introduction), a nonfiction author (among his recent works is Free Trade Rocks! 10 Points on International Trade Everyone Should Know), a podcaster, and an entrepreneur. The views expressed here are his own.