The Fed Waffles

The Federal Reserve raised short-term interest rates by another quarter point on Wednesday. That, by itself, was clear, with the Fed now targeting a range for short-term rates between 4.75% and 5.00%. The problem was that the Fed continues to ignore the most important issue in monetary policy.

That most important issue is the money supply, which surged by 40% in the first two years of COVID, the fastest since the 1940s, and has since dropped by the most since the Great Depression. You would think a central bank would pay attention to the amount of money its policy measures create, but apparently that’s still not a priority for the Fed or the Washington, DC Press Pundits that cover the Fed.

Neither the Fed’s statement on monetary policy nor Fed Chairman Jerome Powell’s post-meeting press conference mentioned the money supply. Nor did anyone in the press ask him one question about it. Which is weird because it’s the most obvious explanation for what happened with inflation the last few years.

If low short-term interest rates, all by themselves, caused high inflation we would have had very high inflation in the aftermath of the Great Recession and Financial Panic of 2008-09, back when short-term rates were kept lower for even longer than during COVID. If “supply-chain disruptions” were the key reason for high inflation then why has inflation remained so high even as the number of ships waiting at ports is back to normal and inventories have recovered?

By contrast, if you follow the M2 measure of money you would have seen the inflation surge coming.

Instead, the Fed continues to dwell on its target for short-term rates and where it might be headed in the next few years. The new “dot plot” from the Fed suggests one more quarter-point rate hike this year, although seven of eighteen policymakers thought rates would peak even higher.