Trevor Dobbs, Staff Writer
As of January 2019, the Federal Reserve has been giving signals that it will begin winding down its contractionary monetary policy it has pursued for the last two years.
This is a sigh of relief for investors, homeowners and business owners alike. The Federal Reserve Chair Jerome Powell has indicated not only does he wish to pursue a pause in his bond sell-off policy, but also that he wishes for an indefinite end of such policy “soon.” While there are benefits to this recent policy direction change, such a move is not without its consequences.
There are many theories as to why this might be the case, but my hypothesis is that presidents usually get the monetary policy that they want. Trump has constantly expressed his concern and disagreement with Powell’s bond sell-off. The Fed, being an independent private entity, does not actually have to obey any direct instructions by the Trump Administration. However, it is clear by taking a look at history, the Fed is not completely independent of the soft power that the office of the current presidential administration yields.
There are currently many assets, mostly in the form of U.S. Treasury bonds, sitting in the form of excess reserves on the balance sheets of the Federal Reserve. These assets on the Federal Reserve’s balance sheets are a direct result of the quantitative easing policy implemented under the Obama Administration to pump liquidity into the economy during the economic recession of 2008. The question for the past two years that has raised, as the economy begins to dramatically improve, and the banks begin to lend again, is how this liquidity can be controlled. More specifically, how can the Fed adequately get rid of this excess liquidity to achieve its price stability targets without over-contracting the economy via the sale of those bonds through their repurchasing agreements or letting that liquidity get loaned out by banks and cause major demand-pull inflationary concerns as a result of expanding the money supply in an increasingly non-elastic economy that has recently reached full employment?
The Fed, until recently, has chosen to take the route of contractionary monetary policy: to instruct the Federal Open Market Committee (FOMC) to sell the bonds off its balance sheets to the tune of around $50 billion per month. Such a policy has resulted in interest rates rising quickly, causing a great amount of volatility in the stock market and raising concerns in the housing market as many people begin to fear the bursting of yet another housing bubble.
If I were to propose an idea for this situation, I would choose to take care of two issues at once; I believe the best-case scenario is neither of these options. I believe either option puts us at too much risk for economic turmoil. If we do nothing, all that excess liquidity gets loaned out into the economy and can risk too much inflation. If we should continue a contractionary policy by selling off bonds, we again put the economy at risk. While the situation could be sufficiently mitigated with perhaps a lighter $20 billion per month sell-off, instead of raising interest rates or allowing the liquidity to burst out, I would prefer that the Federal Reserve make an exchange.
A possible exchange that could take place would be U.S. Surplus property (currently valued at $1.3 trillion) and other U.S. Government assets swapped for special-issue, non-marketable federal bonds via the Social Security Trust Fund at a pace of $20 billion per month. This would take out excess liquidity from the Federal Reserve’s balance sheets without contracting too much, currently set at $4.5 trillion, and fund Social Security liabilities. The currency produced from this transaction could be extinguished, and instead of having to ask the treasury for this money later, there will be an asset to take care of this.