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July
05
2022

The Federal Reserve’s Policy Is Mistaken
Paul Craig Roberts

Normally, recessions are the result of a reduction in liquidity by the Federal Reserve, the central bank, which is signaled by a rise in interest rates.  Normally, recessions are short-run affairs of 6 to 9 months.  Unemployment, which is as costly in its way as inflation, causes the Federal Reserve to relent and to increase liquidity, which is signaled by a reduction in interest rates.

This approach assumes that inflation is a monetary phenomenon–too much money chasing too few goods.  But is the current inflation a monetary inflation?  The Federal Reserve’s response to the financial crisis of 2008-2009, itself caused by the deregulation of the banking system, was to create $8.2 trillion in new money with which to purchase troubled bank investments that threatened the large  banks’ balance sheets and transfer the troubled instruments to the Federal Reserve.  This money did not go into consumer prices. Instead it drove up stock, bond, and real estate prices.  The Fed stayed with this policy, which drove up the prices of financial assets, for over a decade, concentrating wealth in few hands.  

The likely cause of the current inflation in US consumer prices is supply disruption.  The Covid lockdowns and mandatory closing of businesses disrupted and destroyed supply chains. Shipping disruptions, which certainly reduce the supply of goods in an economy such as the United States, a country that has offshored so much of its manufacturing for internal markets, further reduced supply. Economic sanctions against Russia have destroyed business relationships.  When too much money chasing too few goods is the consequene of supply reductions, not monetary growth, the problem needs to be addressed from the supply-side.  Higher interest rates actually raise costs and further restrict supply.  

According to the Atlanta Federal Reserve bank, the US economy is in a second quarter of negative economic growth, that is, the economy is declining, not growing. Deutsche Bank supports this view.  Other large banks forecast a decline in growth.  Recession will worsen supply shortages if it is accompanied by the normal reduction in domestic spending and layoffs of employees.  In other words, the problem the US and associated economies face is not recession per se, but the Fed’s misunderstanding of the cause and utilization of a mistaken policy. 

Even in its own terms, the Federal Reserve’s policy of restricting aggregate demand through higher interest rates will fail if it is offset by federal deficit spending, such as to finance Ukraine’s ability to wage war.

The Federal Reserve’s policy not only worsens supply aspects, but also threatens the accumulated wealth from years of high liquidity, as evidenced by the recent decline in stock and bond prices.  If these reductions in the prices of financial assets threaten the banking, insurance, pension, and real estate sectors, the Federal Reserve will be forced to abandon its program of raising interest rates.  If the supply issues are not addressed, fear that the Federal Reserve has lost control of inflation could result in financial panic that would be self-intensifying.

 

Hon. Paul Craig Roberts is the John M. Olin Fellow at the Institute for Political Economy, Senior Research Fellow at the Hoover Institution, Stanford University, and Research Fellow at the Independent Institute. A former editor and columnist for The Wall Street Journal and columnist for Business Week and the Scripps Howard News Service, he is a nationally syndicated columnist for Creators Syndicate in Los Angeles and a columnist for Investor's Business Daily. In 1992 he received the Warren Brookes Award for Excellence in Journalism. In 1993 the Forbes Media Guide ranked him as one of the top seven journalists.

He was Distinguished Fellow at the Cato Institute from 1993 to 1996. From 1982 through 1993, he held the William E. Simon Chair in Political Economy at the Center for Strategic and International Studies. During 1981-82 he served as Assistant Secretary of the Treasury for Economic Policy. President Reagan and Treasury Secretary Regan credited him with a major role in the Economic Recovery Tax Act of 1981, and he was awarded the Treasury Department's Meritorious Service Award for "his outstanding contributions to the formulation of United States economic policy." From 1975 to 1978, Dr. Roberts served on the congressional staff where he drafted the Kemp-Roth bill and played a leading role in developing bipartisan support for a supply-side economic policy.

In 1987 the French government recognized him as "the artisan of a renewal in economic science and policy after half a century of state interventionism" and inducted him into the Legion of Honor.

Dr. Roberts' latest books are The Tyranny of Good Intentions, co-authored with IPE Fellow Lawrence Stratton, and published by Prima Publishing in May 2000, and Chile: Two Visions - The Allende-Pinochet Era, co-authored with IPE Fellow Karen Araujo, and published in Spanish by Universidad Nacional Andres Bello in Santiago, Chile, in November 2000. The Capitalist Revolution in Latin America, co-authored with IPE Fellow Karen LaFollette Araujo, was published by Oxford University Press in 1997. A Spanish language edition was published by Oxford in 1999. The New Colorline: How Quotas and Privilege Destroy Democracy, co-authored with Lawrence Stratton, was published by Regnery in 1995. A paperback edition was published in 1997. Meltdown: Inside the Soviet Economy, co-authored with Karen LaFollette, was published by the Cato Institute in 1990. Harvard University Press published his book, The Supply-Side Revolution, in 1984. Widely reviewed and favorably received, the book was praised by Forbes as "a timely masterpiece that will have real impact on economic thinking in the years ahead." Dr. Roberts is the author of Alienation and the Soviet Economy, published in 1971 and republished in 1990. He is the author of Marx's Theory of Exchange, Alienation and Crisis, published in 1973 and republished in 1983. A Spanish language edition was published in 1974.

Dr. Roberts has held numerous academic appointments. He has contributed chapters to numerous books and has published many articles in journals of scholarship, including the Journal of Political Economy, Oxford Economic Papers, Journal of Law and Economics, Studies in Banking and Finance, Journal of Monetary Economics, Public Finance Quarterly, Public Choice, Classica et Mediaevalia, Ethics, Slavic Review, Soviet Studies, Rivista de Political Economica, and Zeitschrift fur Wirtschafspolitik. He has entries in the McGraw-Hill Encyclopedia of Economics and the New Palgrave Dictionary of Money and Finance. He has contributed to Commentary, The Public Interest, The National Interest, Harper's, the New York Times, The Washington Post, The Los Angeles Times, Fortune, London Times, The Financial Times, TLS, The Spectator, Il Sole 24 Ore, Le Figaro, Liberation, and the Nihon Keizai Shimbun. He has testified before committees of Congress on 30 occasions.

Dr. Roberts was educated at the Georgia Institute of Technology (B.S.), the University of Virginia (Ph.D.), the University of California at Berkeley and Oxford University where he was a member of Merton College.

He is listed in Who's Who in America, Who's Who in the World, The Dictionary of International Biography, Outstanding People of the Twentieth Century, and 1000 Leaders of World Influence. His latest book, HOW THE ECONOMY WAS LOST, has just been published by CounterPunch/AK Press. He can be reached at: [email protected]

 

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