Moving from “ex ante” to “ex post”
In the annual end of summer economic policy symposium sponsored by the Federal Reserve Bank of Kansas City (virtual for 2020), the theme this year was “Navigating the Decade Ahead: Implications for Monetary Policy.” Chair Powell of the Federal Open Market Committee (FOMC or the Committee) used this occasion to announce the amendment to the Statement on Longer-Run Goals and Monetary Policy Strategy.
This affirms further that, for as long as there is a low r-star and u-star with a flat Phillips Curve, even during good economic times, we should expect an ultra-accommodative monetary policy. Thus, the famous line by Chair Powell during his June 10, 2020, press conference: “We’re not thinking about raising rates; we’re not even thinking about thinking about raising rates” is the new normal. This realty of “as far as the eyes can see” low rates has at least three ramifications.
- Continuing to reward borrowers (financial repression) will eventually create great instability in the economy due to over-leveraging in all sectors – ballooning of government, corporate and household balance sheets.
- Keeping the “risk free rates” low, all other assets, especially financial assets, will continue their upward trajectory in asset prices and return which further exaggerates income and wealth divide and promotes political instability. This would make monetary financing and universal income the rule rather than the exception.
- The thirst for yield and return in a low interest rate environment persistently brings underestimation of risk and discounting to risk taking (the Fed provides the backstop). When future systemic shocks happen, such as an unexpected jump in inflation, the corresponding rise in risk free rates would force repricing of assets downward speedily and significantly.
In the meantime, take risk and the Fed has your back!
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