The Federal Reserve is in danger of losing control of how it sets
interest rates, according to the former chairman of the Senate Banking
Committee.
Texas Republican Phil Gramm argues in
a Wall Street Journal op-ed that the central bank’s attempt to normalize
interest rate policy while it also reduces the size of the securities it holds
on its balance sheet could go terribly wrong.
In a piece co-authored with Thomas S. Saving, a former director of the
Private Enterprise Research Center at Texas A&M University, Gramm notes the
intensifying debate over whether the Fed should be raising interest rates. The
central bank hiked
its benchmark rate four times in 2018 and reduced the amount of Treasurys
and mortgage-backed securities it holds by $136 billion, or 3.4 percent, to
$3.88 trillion.
President Donald Trump
has repeatedly criticized Fed Chairman Jerome Powell and his colleagues for
policy tightening. Markets have been in turmoil as well, with stocks
threatening to fall into bear market territory.
“Extraordinarily,
this debate is occurring at the very moment the Fed — shackled by its bloated
asset holdings and the resulting excess reserves of the banking system — has
less ability to control interest rates than it has had in its entire 105-year
history,” Gramm wrote.
The issue is
the balancing act the Fed must perform as it seeks to normalize policy from the
extreme accommodation of the financial crisis and the years after.
The Fed is
both raising rates and reducing bonds it holds on its balance sheet, and in 2018
ran into an issue in which the benchmark funds rate veered close to and
eventually matched the same level as the interest the Fed pays on excess bank
reserves. Gramm pointed out that should the market rate banks can make on loans
exceeds the level the Fed pays on reserves, it could result in an explosion in
the money supply that would drive inflation.
”[T]he
danger posed by the Fed’s bloated asset holdings and the resulting massive
level of excess bank reserves is that with a full blown recovery now under way,
the demand for credit will accelerate and force the Fed to move quickly to
raise interest rates on reserves or sell securities to sop up excess reserves,”
Gramm and Savings wrote. “A small error by the Fed in following market interest
rates could cause a large change in the money supply.”
The op-ed
places much of the blame for the current situation on “monetary excesses”
during the administration of former President Barack Obama.
Gramm
himself, though, has often been cited by critics for contributing to the
financial crisis. He advocated the repeal of the Glass-Steagall Act that had
mandated the separation of retail and investment banking, and pushed for
deregulation of the credit default swaps that played a key role in Wall
Street’s crisis-era troubles.
He expressed
some optimism that the Fed will be able to navigate its way through the current
situation but said it will take time.
“While the
Fed is not forever shackled by the monetary excesses of the Obama era, the
sheer size of its asset holdings virtually guarantees that the Fed will feel
the yoke of the massive excess reserves in the banking system for the remainder
of this recovery,” he wrote.
Source: CNBC