August 24, 2006

• WORD

  "Fortunately, for the prospects for future dollar inflation, further declines in the dollar are not very likely and future world growth will taper off. But far more important for the future of inflation than these transitory phenomena is the absolutely stellar policy of the Federal Reserve in controlling the rate of growth of the monetary base. Fed policy couldn't be better.

  
  

  The Fed's primary policy instrument is its control over the monetary base, which is comprised of currency in circulation and member bank reserves. The Fed creates a lot of hoopla making pronouncements about targeting the federal funds rate, but the long and the short of it is that the Fed is neither a borrower nor a lender in the federal funds market. In times past, the Fed did use the discount rate and loans through the discount window as a policy tool, but no longer. Changes in the federal funds target rate are basically a reaction to changes in the 91-day Treasury bill yield and not a signal of prospective policy. The monetary base, however, is the key to Fed policy and future inflation.

  
  

  It is here where the Fed has deliberatively and purposively kept the reins on inflation during a rather turbulent time. The Fed not only avoided a massive financial catastrophe in the aftermath of the 9/11 attacks, but has also maintained tight control over the monetary base as the economy strengthened and the dollar fell. In the nearby chart is a plot of the log of the monetary base since early 2001. The spike in the monetary base circa Sept. 11, 2001, reflects the Fed's wisdom to discount freely in times of crisis and then remove that excess monetary base when the crisis is over to avoid inflation.

  
  

  Post-9/11, the Fed has gradually lowered the growth rate of the monetary base to offset any tendencies for inflation to get a foothold as the dollar fell and world growth surged. The job the Fed has done has been flawless, nothing short of amazing. Walter Bagehot would have been impressed were he alive today. And the financial markets know it. "

  
  

  word to yo motha

  • 11:30 am
  • 1 Comment