Is the Fed reckless?

Recently, on Mar. 18th, the Federal Reserve lowered the Fed Funds rate to 2.25%. In the accompanying statement, the Fed said the following:

“Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

Inflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.

Today’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.”

Essentially, the Fed is saying that growth is so weak right now that, when we consider our dual mandate of growth and inflation, we have to put our eggs all in the growth basket. The Fed is betting that inflation, while high, will moderate in the coming months, as it is a lagging indicator.

Well, according to my analysis, headline inflation is well over 4% now. The Fed has essentially been giving money away since December because the Fed Funds has a negative real interest rate (The Fed Funds rate minus headline inflation). With inflation way above this economy’s comfort zone, one has to ask: is the Fed reckless? One should also ask whether negative real interest rates are warranted in any economic climate. I thought the Fed was the lender of last resort, not the bartender feeding drinks to a drunk with a hangover.

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