The Costs of Fighting Inflation: Slow Growth, Slow Lending and Slow Housing Recovery

The Federal Reserve wants to avoid runaway inflation (or hyperinflation) while generating increased economic growth. So what is the cure for inflation? Slow down bank lending.

But the cure might be worse than the problem itself. The Federal government has been commandeering private lending for a couple of decades and now has a virtual monopoly of certain types of lending. Examples include the mortgage market where (depending on the source) the government (Fannie Mae, Freddie Mac and the FHA) control 86-90% of the market. Student loans is another example where the government stepped in to guarantee loans at taxpayer expense. Regulatory agencies such as the FDIC and The Federal Reserve have been clamping down on credit availability and risk-taking by lenders.

The result? Despite The Fed’s efforts at pushing down interest rates to help generate economic growth, the result has been a collapse in the money multiplier and money velocity (or how fast money supply circulates through the economy).

The M1 Money Multiplier has crashed to .898. That means for every $1 increase in the monetary base, the money supply only increases by 79 cents.

Why? Because the banks continue to build up their excess reserves, instead of lending out money.

The excess reserves are deposited at the Federal Reserves where they are trapped (or sterilized).

So until banks start lending again in great amounts, we are likely to see continued slow growth. Another measure of monetary policy (in)effectiveness is M2 Money Velocity. Like the M1 Money Multiplier, it has fallen dramatically since 2008.

Another measure of money velocity is GDP/Adjusted Monetary base. This measure shows even a sharper decline in 2008 to today. Today’s money velocity is lower than is was after the end of World War II.

If we look at a different multiplier, the government debt multiplier (GDP/Federal debt), we can see a similar pattern. GDP growth is not being improved by the frantic borrowing of the Federal government.

In his op-ed in the Financial Times, Harvard economist Ken Rogoff argues that the world is right to worry about US debt. The government is borrowing more and more money to spend, without much a positive effect.

I have just shown that The Fed’s “war on inflation” has resulted in slow economic growth because of lack of bank lending. And between the recent attacks on banks by the Consumer Financial Protection Agency (CFPC) and misguided “robosigning” settlements, the banks are less than enthusiastic about lending on housing.

This can be seen by looking at the Mortgage Purchase Application index produced by the Mortgage Bankers Association. Essentially, it shows a similar pattern to the M1 Money Multiplier and M2 Money Velocity in that it is back to levels not seen since the mid 1990s.

So, as some argue that there is a housing bubble forming, it is NOT a traditional homeownership, debt-fueled recovery. Rather, it is an investor (hedge funds, corporations, foreign investors (e.g., Chinese national investors)) recovery or bubble.

It am not arguing for a return to another debt-fueled “affordable” housing recovery since it is blew up so badly. Rather, I am simply explaining why the economy and housing markets are not recovering as fast as some had hoped, despite all-time low interest rates.

Bank reserves are still trapped in the Federal Reserve system. Unleashing it would likely cause inflation, but also economic growth.

Yes, some people (including me) have argued that there is indeed inflation in the economy. Here is John William’s estimate of actual inflation from Shadow Government Statistics.

But just think what would happen if regulators and The Fed unleashed the reserves on an unsuspecting population!

the banks will NOT lend more money because...
the federal govt has made residential mortgage lending impossible to justify from a business standpoint... (except if the fed govt is the lender and the bank only the frontman).....
the federal government has seized control also over all student loans,
the federal government has made business and investing almost impossible of success (higher taxes, almost-impossible-to-comply-with burdensome regulatory overload, new Obamacare taxes, etc.)..... so a banker would be stupid to lend to most businesses these days, especially small businesses which are not part of the federal-fascist machine (like GE or GM)

result of the federal govt’s actions:
almost no residential loans, no student loans, almost no business loans....especially small business loans...

so what is a bank to do with any money it has? just what the banks have been doing... putting the $$ into the stock market (rigged, of course, but pretty much the only game in town left for them ....so they do it...)

do not expect the banks to begin making home loans or business loans, etc... available again on any significant scale until such time as fascism/communism/progressivism/whateverthehellitis-ism is terminated in WashDC ... and the banks are permitted once again to resume regular lending

The masterminds at The Fed ....

It is one thing to slow inflation - if there is really inflation - for a short period of time. However we are now 15+ years into this as a means of encouraging economic growth, not controlling inflation. Back in the dot.com days when the economy was expanding, these artificial Fed stimulants should have been removed.

Now that the economy has gone into total stagnation, removing them now and letting Fed interest rates rise back from 0% to traditional 4%'s will certainly kill the economy deader than a door nail.

Imagine your typical low informed voter dealing with a 400% increase in borowing rates? Joe Dumb Voter does not recall anything but zero Fed rates (most are not old enough).Political suicide.

The Fed has painted itself into a horrible corner.

“removing them now and letting Fed interest rates rise back from 0% to traditional 4%’s will certainly kill the economy deader than a door nail.”

The problem is that this rate is artificial. Lending will always occur when the terms of the loan are beneficial to the lender - meaning that the interest rate has to compensate for lender risk.

Keeping the rate lower than the risk incurred - simply results in no lending at all - pumping up deflation. What happens in deflation? The money that you do have is worth more every month. This article is basically admitting that deflation is king right now.

Deflation for the foreseeable future is the only result of Fed policies. This is why the money velocity is so low.

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