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For a Fed Running Out of Options, It’s the Rock or the Hard Place

Mises Institute  ( Original )
MAR 1, 2018

Don’t be fooled. It’s as simple and straightforward as it seems, no matter what doublespeak the Fed and its allies spew forth.

It is not possible to intervene, time and time again, to prevent the collapse of asset bubbles without commensurate consequences. And every effort to forestall these consequences reduces your ability to do so, and makes the eventual pain you will have to suffer worse by corresponding degrees.

There is no such thing as a fiscal policy free lunch. You always pay the price eventually. Always.

To keep the massive monetary stimulus that is inflating asset prices from doing the same to consumer prices, the Fed will need to throttle the conversion of excess reserves into demand deposits by raising the IOR rate. However, this could squeeze short-term and long-term rates, invert the yield curve, and trigger recession.

If the Fed chooses to keep the IOR rate at 1.5% and the economy continues to pick up steam, due in part to tax reform and regulation rollback, bankers will lend unemployed reserves to consumers and firms. This could set the stage for an encore performance of 1970s-style inflation.

The Fed is between a rock and a hard place. It is damned if it normalizes rates and is damned if it does not. If it does not, it will after its massive monetary expansion, which has inflated asset prices, begins to inflate consumer prices.

When the Fed finally normalizes rates, asset prices will collapse, negative returns on heavily leveraged asset will be realized, leveraged investments will be underwater, loan defaults will rise, asset bubbles will pop, and the boom will bust.

ORIGINAL SOURCE: Inflation Has Been Contained — But Not Because of a Liquidity Trap at Mises Institute on 2/28/18