Monetary easing and bailout expectations are entrenched in the central bank after 2008, often justified by systemic stability or public expectations. The truth is that in addition to fueling moral hazard, the Fed hinders innovation and productive investment.

Go big or go home

Shying away from accommodative monetary policy does not work well with the zeitgeist of 2021. After the Covid disaster, going big is the only game in town – and this time in monetary and fiscal matters. Pandemic-induced transformational necessity justifies Joe Biden’s decision historically unprecedented spending plans to accelerate the net zero transition, boost digitization and improve education and health. Public support for clean technology and a reasonable tax hike as a cushioning mechanism against exorbitant inequalities resonates well with moderate free traders and the entrepreneurial class.

If the sweeping US fiscal expansion is justified, then why not prolong monetary activism – at least for the foreseeable future? There are a host of arguments in favor of a perpetual “ Fed put ” (the implicit floor below asset prices due to interest rate cuts after a credit crunch or other shocks). Some of them are systemic, while others take into account the phenomenon of mass financialization. These are worth addressing as they are less visible in intellectual discourse.

Some researchers argue that the democratization of leverage – that is, the diffusion of credit among the middle class – led to massive Federal Reserve interventions during and after the financial crisis in response to public expectations. . In the current context, the boom in retail investment, fueled by low-cost trading platforms, stimulus checks and lockdowns, raises the stakes for financialized individuals, who have become accustomed to the Fed put and , Therefore, wait its continuity.

Public opinion

However, I fail to see how public expectations – existing or not – can decisively shape monetary policy. Conventional wisdom says that it is central banks that shape public expectations and not the other way around; this is how long-term inflation is anchored. After all, the two pillars of the modern central bank – institutional independence and inflation targeting – have emerged from the ashes of stagflation to cushion upward pressure, not to accommodate it. Central bank independence is not a majority institutional arrangement. And what determines Jay Powell’s persistence on supportive monetary policy is not the wishes of the crowd of retailers or middle-class mortgage borrowers. Yes, he’s accountable to Congress for the Fed’s dual tenure, but he doesn’t need voters’ permission to decide on the appropriate policy mix. It is an irresistible nostalgia for the great era of moderation that drives Mr. Powell’s openly risky bet on a robust recovery that will only be accompanied by fleeting inflation.

Facts

Interpretations aside, facts speak louder than words: As post-dotcom easing aimed to cut interest rates and 2008 balance sheet expansion targeted mortgage-backed securities, the Fed argues now the entire financial system. To avoid a cascading effect of defaults due to Covid, the Fed accepted a unprecedented range of guarantees, this time including blue chip corporate debt and ETFs listing low quality corporate bonds.

Moral hazard, in other words, the extraordinary decoupling of risk-taking from macro-fundamentals and the market environment, has disastrous consequences. Corporate debt has skyrocketed since the start of the coronavirus crisis. High yield corporate issuers’ debt levels are reaching alarming levels of the dotcom era, while investment grade leverage has reached an all time high. record in the pandemic year 2020. According to an analysis of the Financial Times, last year, borrowings in corporate bond markets climbed to about $ 2.5 billion, reaching an all-time high. Meanwhile, the recent The Archegos debacle demonstrated the risks posed by the margin debt boom last year.

The Fed has now cut back on its corporate credit facilities, but investors are well aware that institutional innovations in previous crises are path dependency. They know that, if necessary, the Fed will start over. The Fed’s put therefore remains in place, albeit more implicitly, fueling an endless Minskian loop: crisis, lower spreads between risk-free and riskier rates, monetary easing which leads to breathtaking stock market rallies, excessive leverage and cavalier strategies. search for yield. In turn, this sows the seeds for the next crisis, which will inevitably lead to even more sweeping bailouts and swelling central bank balance sheets.

Think long term

It could be argued that unblocking credit to let it flow through the arteries of the real economy more than offsets the risks associated with asset price inflation and ever higher debt ratios. In my opinion, this thesis is dangerously simplistic. The abundance of post-crisis liquidity has not been accompanied by high investment ratios in the advanced world. The ultra-low interest rate environment is one of the factors encouraging market concentration, especially in the United States. Monetary easing also tends to favor growth firms in the tech sector that depend on human capital rather than fixed capital formation. In addition, the cheap money and the hoarding of liquidity induced by the stimulus measures create incentives for more buybacks at the expense of long-term investments.

Therefore, there should be no complacency around the causal links between the Fed put and inadequate investment ratios. Granted, I don’t think Keynesian management of the demand side is a panacea, although it is absolutely necessary at critical times in relation to today’s post-pandemic momentum. Market-driven entrepreneurial innovation through Schumpeterian creative destruction is the driving force behind technological progress and economic growth. This process relies on the credit provided by financial institutions, to which Schumpeter attributes special responsibility within capitalism. Unlimited monetary easing distorts this vital role of banks and robs the real economy of the merits of free markets.

Crises almost always mark the beginning of long-term institutional arrangements. Therefore, as soon as possible, policymakers need to send the appropriate signals to the public and plan for a transition to a monetary regime that will once again unleash market forces. It must be done in stages; the sustainable costs of servicing the public debt are the priority now, and rightly so. But the political orientation must be unequivocal. It is time to dismantle the Fed putt.


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