The Fed cut interest rates in 2007 and 2008 in a frenzied response to the mortgage meltdown and the financial panic after the collapse of Lehman Bros. Rates hit zero in late 2008. When that was not enough to stop the panic, the Fed resorted to guarantees of all bank deposits and money market funds, trillions of dollars of currency swaps with the European Central Bank and printing money under a program that became known as “quantitative easing,” or QE.
The money printing continued until late 2014 and zero rates continued until late 2015. Since then, Fed rates have risen to 2.5% and the Fed has begun a program of reducing the money supply to reverse QE. The Fed’s balance sheet, which rose from $800 billion to $4.5 trillion under QE, has since been reduced to about $3.9 trillion through quantitative tightening.
The rate hikes and QT are designed to normalize rates and the Fed’s balance sheet in preparation for the next recession. Other central banks have not been able to normalize.
Japan continues to keep rates below zero and has purchased large quantities of Japanese government bonds, stocks and other securities. The ECB also has negative rates and continues a QE policy.
Now, the U.S. policy seems to be backtracking. The tightening through higher rates and reducing the money supply has pushed the U.S. close to recession. The Fed has realized its mistake and has lately paused its rate hikes, along with preparing to end its QT program.
This article suggests that the Fed may have waited too long to reverse course. It may be the case that monetary tightening is impossible without recession and that central banks may be stuck at zero (or, in the Fed’s case, returning to zero) in order to prop up growth.
Rates may be zero indefinitely. If that’s the case and if governments want to stimulate their economies, they may have to resort to deficit spending monetized by the central bank. This formula is known as “Modern Monetary Theory,” or MMT.
Democrats are counting on MMT to finance both the Green New Deal and their other programs, including Medicare for All and free tuition. The inevitable result of MMT is inflation.
Investors should prepare now for an inflationary outbreak if MMT is pursued. Once the inflation begins, it’ll be too late to take precautions.
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