The Fed would be far more effective in controlling inflation if it were to pare its Balance Sheet versus focusing on the Fed Funds Rate.
Inflation is created by excess money in the economy (“excess” money in that it is not generated from Production output but rather money printing by the Fed). The Fed could pull excess money out of the system by shrinking the money supply via its Quantitative Tightening (“QT”), effort.
- The best way to cure inflation is to shrink the money supply. The Fed shrinks the money supply every time it sells a security from its Balance Sheet or allows a security to mature. This process is known as Quantitative Tightening and runs counter to the Fed’s Quantitative Easing (“QE”) programs.
- The Fed’s Balance sheet is at a near record level ($8.9 trillion), as a result of subsidizing the fiscal stimulus programs of Presidents Trump and Biden combined with executing its QE programs, not to mention subsidizing the fiscal deficit. Every time the Fed subsidizes a fiscal program or fiscal deficit it is printing money and therefore causing inflation. QE also creates inflation as its execution requires the Fed to inject new money into the financial system.
- The Fed is the 800-pound gorilla. Under the Fed’s QT plan it would eventually ramp toward paring its Balance Sheet by $95 billion per month or $1.1 trillion per year of Treasuries and Government agency securities. This would make the Fed the largest seller in the world of Treasuries and Government Agency securities. Once ramped, QT would have a more profound impact on shrinking the money supply and curbing inflation than would the arbitrary setting of interest rates by way of increasing the Fed Funds Rate.
- Get out of the Fed Funds Rate management game. By focusing on QT the Fed would partially unwind its anti-capitalist QE effort. As for the Fed Funds Rate, the Fed could peg the Fed Funds Rate to the 2-year Treasury yield, thereby allowing the market to lead.