Northwest Bank president has some advice for the Fed

Editor’s note: This column first appeared in the July 11 printed edition of the QCBJ. 

While serving as an advisor to Bill Clinton in his successful run for the White House in 1992, James Carville famously coined the phrase “It’s the economy, stupid!”

If asked today to advise a Fed focused on combating inflation solely by increasing short-term interest rates, I would tell them that in my opinion the U.S. is suffering as much or more from the lingering effects of a bloated money supply than it is low interest rates. More directly, “It’s the money supply, stupid.”

In 2008, the Federal Reserve opened up an economic Pandora’s box, stimulating demand in every sector by growing the money supply at an unprecedented rate and increasing the size of its balance sheet to all-time highs.

And while economic historians will forever debate the necessity and effectiveness of this quantitative easing, there is little doubt that failing to more timely unwind the Fed’s balance sheet is the root cause of our current inflationary predicament.

Inflation is simply more dollars chasing a slower growing, static or reduced amount of goods (e.g. can you say “supply chain disruptions” and “labor shortages”). Sustained Fed intervention into the bond market over the last 14 years has caused the number of dollars to grow at a faster pace than the goods and services to be sold, pushing supply and demand further and further out of sync.

And since the Fed’s tools are not really designed to directly impact the supply of goods and services available, especially in the short term, the Fed must focus its attention on reducing demand. Higher interest rates help reduce demand by enhancing the reward for savings. They also discourage the use of debt to fund consumption. In the near term, however, inflation mutes or even moots those effects by reducing money’s future buying power.

So, while increasing interest rates is a part of the solution, after 2008 simply raising rates to try to tighten monetary policy doesn’t lead to shifts in the money supply like it used to. With so many excess reserves in the banking system, the money supply is still more likely to grow than shrink. The only way to reduce excess reserves and reduce the growth of the money supply is for the Fed to reduce the size of its balance sheet by systematically selling off its bond portfolio.

I totally agree with the Fed’s recent announcement to increase interest rates by 75 basis points. And more similar announcements are not only likely, but appropriate. However, please join me in hoping for an announcement, sooner rather than later, about how the Fed plans to more directly slow the growth in the money supply by reducing its balance sheet.

Joe Slavens is president and CEO of Davenport-based Northwest Bank & Trust Co.


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