Haver Analytics
Haver Analytics


Paul L. Kasriel

Mr. Kasriel is founder of Econtrarian, LLC, an economic-analysis consulting firm. Paul’s economic commentaries can be read on his blog, The Econtrarian.   After 25 years of employment at The Northern Trust Company of Chicago, Paul retired from the chief economist position at the end of April 2012. Prior to joining The Northern Trust Company in August 1986, Paul was on the official staff of the Federal Reserve Bank of Chicago in the economic research department.   Paul is a recipient of the annual Lawrence R. Klein award for the most accurate economic forecast over a four-year period among the approximately 50 participants in the Blue Chip Economic Indicators forecast survey. In January 2009, both The Wall Street Journal and Forbes cited Paul as one of the few economists who identified early on the formation of the housing bubble and the economic and financial market havoc that would ensue after the bubble inevitably burst. Under Paul’s leadership, The Northern Trust’s economic website was ranked in the top ten “most interesting” by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets (McGraw-Hill, 2002).   Paul resides on the beautiful peninsula of Door County, Wisconsin where he sails his salty 1967 Pearson Commander 26, sings in a community choir and struggles to learn how to play the bass guitar (actually the bass ukulele).   Paul can be contacted by email at econtrarian@gmail.com or by telephone at 1-920-559-0375.

Publications by Paul L. Kasriel

  • In this commentary I will explain the relationship between the shape of the yield curve, the behavior of nominal thin-air credit and the behavior of real aggregate demand for goods and services. Specifically, I will argue that there is a positive relationship between the “slope” of the yield curve and the percent change in thin-air credit. Further, I will argue that there is positive relationship between percent changes in real thin-air credit and percent change in real domestic aggregate demand for goods and services. For example, the steeper the slope in the yield curve, the faster will nominal thin-air credit grow. In turn, the faster will real domestic aggregate demand grow. The yield curve concept, I will be referring to is the spread between the yield on the Treasury 10-year security vs. the overnight federal funds rate (hereafter referred to as the yield spread). The importance of the federal funds rate in this yield spread will be explained later in this commentary. Thin-air credit for the purposes of this commentary will be defined as the sum of the asset categories of securities and loans on the books of depository institutions (currently, primarily commercial banks). “Thin-air” refers to the fact that the system of depository institutions has the unique ability among various other private lending entities to create credit figuratively out of thin air. (The central bank also has the ability to create credit out of thin-air. In fact, the central bank creates the “seed money” that enables the depository institution system to create thin-air credit.) The important implication of the ability to create credit out of thin-air is that the borrower can spend borrowed funds without necessitating any other entity to reduce its current spending. Thus, when new thin-air credit is created, we can assume that nominal current spending will increase, all else the same. (We cannot determine, a priori, what will be purchased by the borrowers of this new thin-air credit. It could be newly-produced goods and services or it could be existing assets, physical or financial.) We cannot make this same assumption when new credit is extended by non-depository entities. For example, if an individual extends credit, in order to fund that loan, she either has to cut back on her current spending or run down her current deposit holdings. If she reduces her current spending, i.e., increases her saving, no new net spending will occur from this loan because she will merely be transferring her spending ability to the borrower. If she funds the loan by running down her deposits, then there will be some net new spending in the economy. In economist jargon, this would be an example of an increase in the velocity of money. An increase in the velocity of money is another way of stating that there has been a decrease in the public’s demand for money balances. I am not aware of any statistic that measures total transactions in the US economy, transactions that include not only expenditures for newly-produced goods and services but also purchases of existing assets. So, I must rely on expenditures recorded in the National Income and Product Accounts (where the GDP data are reported). Because the bulk of thin-air credit created by US depository institutions goes to domestic borrowers, I have chosen Gross Domestic Purchases as my measure of aggregate domestic demand.

    If you intend to read further, I would advise you have some Red Bulls on ice. It’s going to be a long one. Plotted in Chart 1 are quarterly averages of the level of federal funds rate (the blue line) and the yield spread between the Treasury 10-year security and the federal funds rate (the red bars). The gray shaded areas demarcate periods of recession. Notice as the federal funds rate declines, the spread tends to widen. Similarly, as the federal funds rate rises, the spread tends to narrow, sometimes going into negative territory. Why might this be, especially, why might the spread narrow when the federal funds rate rises? Remember, the Federal Reserve sets the level of federal funds rate. It does so by regulating the supply of cash reserves it creates out of thin-air in relation to the amount of these reserves demanded collectively by depository institutions (hereafter, banks). Prior to March 26, 2020, the Fed imposed reserve requirements on banks. That is, banks were required to hold as cash reserves (either on deposit at the Fed or as coin/currency in their vaults) in an amount equal to a specified percentage of their deposits. The Fed varied this percentage from time to time for reasons known only to the Fed. Prior to October 9, 2008, when the Fed began paying interest on reserves held by banks, these required reserves largely defined banks’ demand for reserves. If the Fed wanted to increase the level of the federal funds rate, it would reduce the amount of reserves it supplied relative to banks’ demand for reserves. Even if the Fed had not imposed reserve requirements on banks, they still would have had a demand for reserves. Banks would want to maintain a certain level of reserves to cover their clearings with other banks. As mentioned above, on October 9, 2008, the Fed began paying interest to banks on their reserves holdings. The reason it did so was to increase banks’ demand for reserves. In November 2008, the Fed began its first round of quantitative easing (QE), which added reserves to the banking system, but had not yet lowered its federal funds target to zero. In order to prevent the federal funds rate from falling to zero, the Fed induced the banking system to hold these extra reserves by paying them interest on their reserves holdings. Eventually, the Fed lowered its target for the federal funds rate to zero, yet the Fed continued to pay interest on reserves held by banks’ as it still does to this day. Why?

  • There is an economist in Chicago who has been known to see a silver lining behind every cloud. For example, after some natural disaster that resulted in hundreds of millions of dollars of damage to structures, this economist had been known to say that on the bright side, think of the rebuilding activity that will take place. By this logic, if the federal government wanted to increase the pace of economic activity, it could call on the US Air Force to carpet bomb some selected suburb, giving the residents plenty of notice to vacate the their premises with their irreplaceable possessions. (You might want to Google Bastiat’s “broken window fallacy” for the nonsense of this). I bring this up because after the debt-ceiling increase/extension legislation was signed into law on June 3, 2023, analysts, who unlike the aforementioned Chicago economist, see a cloud behind every silver lining. Even before the debt-ceiling bill hit the desk of President Biden, these nattering nabobs of negativity (you youngsters can Google this phrase) were saying that the rebuilding of Treasury balances at the Fed would suck liquidity out of the financial system, which, in turn, would cause all sorts of unspecified problems in the financial markets.

    All else the same, it is true that an increase in Treasury deposits at the Fed would drain reserves from the banking system. But all else has not been the same in this case. Let’s go to Chart 1. Plotted in Chart 1 are the four-week billions of dollars changes in reserve balances held at the Fed by depository institutions (the blue bars), Treasury deposits at the Fed (the red line) and reverse repurchase agreements (RRPs) with the Fed (the green line). The last data points plotted are for the week ended June 28, 2023. In the four weeks ended June 28, Treasury deposits at the Fed increased by $360 billion, which, all else the same, would have drained that amount of reserves from the banking system. Yet, in the four weeks ended June 28, reserves at the Fed contracted by only $29 billion (the last blue bar plotted). Evidently, all else was not the same. One major factor that was not the same was the amount of RRPs executed with the Fed. An increase in RRPs drains reserves from the banking system; a decrease in RRPs adds reserves. In the four weeks ended June 28, RRPs executed with the Fed declined by $344 billion, which offset all but $16 billion of the reserves drained via the increase in Treasury balances at the Fed.

  • The year-over-year change in the All-Items CPI for May 2023 was 4.13%. My forecast is that the year-over-year change in the All-Items CPI for June 2023 will be less than 4.13%. Barring revisions, the seasonally-adjusted month-to-month percent change in the June CPI would have to be 1.19% non annualized for the year-over-year change in the June All-Items CPI to be equal to May’s 4.13%. Coincidentally (I think), the last time the month-to-month non-annualized change in the CPI was as high as 1.19% was June 2022, when it was exactly 1.19%. If the June 2023 All-Items CPI increases by 0.55% (non-annualized), the average non-annualized percent change in the CPI in the three months ended May 2023, the June 2023 year-over-year change in the CPI would slow to 3.47% vs. May’s 4.13%.

    This is not economics. Rather, it is arithmetic. And it is all about that June 2022 base. (It took me a while, but I got there.) Plotted in Chart 1 are the month-to-month annualized percent changes in the All-Items CPI (the blue bars) along with the monthly observations of the year-over-year percent changes in the All-Items CPI (the red line). The June 2022 CPI increased a whopping annualized 15.22%. The June 2022 level of the CPI is the base for the June 2023 year-over-year percent change observation. With such a high June 2022 base, the bias is for a slowing in the year-over-year percent change in June 2023. The year-over-year percent changes in the All-Items CPI beyond June 2023 are not likely to slow as much because the high June 2022 base will drop out of the calculation. However, in the 11 months ended May 2023, the All-Items CPI has increased an annualized 3.17%. So, barring some negative supply shock in the remainder of 2023, the year-over-year change in the December 2023 All-Items CPI is likely to be much lower than the 6.44% for December 2022. For example if the CPI increases a non-annualized 0.3% from June through December 2023, the December 2023 year-over-year change in the All-Items CPI would be 3.59%. I believe that the monthly non-annualized changes in the All-Items CPI will, on average, be less than 0.3%. Thus, I believe that the year-over-year change in CPI as of December 2023 will be less than 3.59%.

  • Yes, but energy prices fell by 3.6% month-to-month and food prices were up only 0.2%. Used motor vehicle prices account for only 2.75% of the CPI while food and energy prices account for 20.30% of the CPI. Typically each month some consumer prices rise and some prices fall. That is why when we try to measure the overall change in consumer prices we use a weighted price index, the weights being determined by the estimated relative importance of the different items purchased by a representative household.

    Let’s look at the annualized percent changes in the All-Items CPI over one month, 3 months, six months and 12 months, which are plotted in Chart 1. As of May 2023, the annualized percent change in the CPI was 4.13%, 3.17%, 2.20% and 1.50% over 12 months, six months, three months and one month, respectively. In May 2022, these changes were 8.50%, 9.21%, 9.69% and 11.62%.

  • The Bureau of Economic Analysis’s first guess at real GDP annualized growth in Q1:2023 was a paltry 1.1%. Bear in mind that the BEA does not yet have March 2023 data for business inventories, net exports or construction expenditures. With only full January and February inventories data, the estimated change in real business inventories in Q1 “contributed” minus 2.3% to the annualized percent change in Q1 real GDP. Who knows, perhaps the March inventories data will reduce the magnitude of the drag on real GDP growth from this component.

    In contrast to the drag on Q1 real GDP growth from real business inventories, real Personal Consumption Expenditures (PCE) contributed 2.5% to Q1 annualized real GDP growth. At an annualized rate, Q1 real PCE increased 3.7% versus 1.0% in Q4:2022 and the fastest growth in real PCE since the 12.1% recorded in Q2:2021. Given that real PCE accounted for around 71% of real GDP in Q1, the economy seemingly was on fire in Q1, right?

    Wrong! Let’s take a look at the behavior of monthly real PCE as compared to its quarterly average. This is shown in Chart 1 below. The blue bars in Chart 1 represent the month-to-month annualized percent changes in real PCE. The red bars represent the quarter-to-quarter annualized percent changes in real PCE. So, the annualized growth of 3.7% in real PCE in Q1:2023 was the result of the outsized 17.6% annualized growth in January 2023 PCE growth. Monthly real PCE contracted in February and March 2023. In fact, real PCE contracted in four of the past five months. It seemed as though a myriad of measures of economic activity were very strong in January, very strong, as a former president might say. Could it have been that January 2023 was uncharacteristically warm?

  • In the wake of the FDIC-mandated closings of Silicon Valley Bank and Signature Bank, deposits at commercial banks have declined a net $161.0 billion in the two weeks ended March 15, 2023 (see Chart 1 below). In that same two-week period, money market funds that invest in US government securities and repurchase agreements collateralized with US government securities experienced a net inflow of $130.8 billion, according to the Investment Company Institute. These money market funds gained another $131.8 billion in the week ended March 22, 2023. Each share in these money market funds is valued at $1 or par. But there is no federal guarantee that these shares are redeemable at par. Yet there were large inflows of monies into these taxable government money market funds at the same time there were large outflows of deposits from commercial banks. Deposits at commercial banks are insured to be payable at par of up to $250 thousand per account ($500 thousand for joint accounts) by the Federal Deposit Insurance Corporation (FDIC). It would seem that the nonbank public has more confidence in the full faith and credit of the US government than the FDIC (unless the federal government is forced to default on its debt because of Congress failing to increase the ceiling on Treasury debt issuance). To the best of my knowledge, no government-only money market fund has ever experienced a decline in its share value below $1. Assuming that the debt ceiling is raised in time to avoid a Treasury default, do we really need federal deposit insurance?

  • The Federal Reserve reminds me of a fire chief who moonlights as an arsonist. The Fed aids and abets in the setting of inflationary fires and then runs to extinguish them. In this commentary I will argue that the Fed’s response to the COVID-19 pandemic and the unprovoked invasion of Ukraine by Russia exacerbated and prolonged the inflationary impulses of these events. Furthermore, I will hypothesize that the Fed is going to pursue a more restricitve policy longer than necessary to extinguish the inflationary fire it helped set, the result of which will be a deeper-than-necessary recession. The Fed is not malicious. Rather, it is ignorant. At his semi-annual appearance before the Senate Financial Services Committee on March 7, Fed Chairman Powell stated that the Fed does not know what the level of the “neutral” federal funds is now and that the neutral level is not constant through time. Yet, the Fed persists in conducting its monetary policy by setting the level of the federal funds rate, not knowing whether the level set is above or below the neutral level of federal funds rate.

    When it became obvious to all that there was COVID-19 pandemic in March 2020, real production of goods and services in the US and in many other regions of the world collapsed as business shutdowns occurred. This represented a negative supply shock. If nominal aggregate demand remained the same in the face of this negative supply shock, higher prices would result. The changes in the sum of depository institution credit (loans and securities on the books of these institutions) plus the monetary base (the sum of currency in circulation and reserves held at the Fed by depository institutions) are postively correlated with changes in nominal aggregate demand. Let’s call the sum of depository institution credit plus the monetary base “thin-air” credit because both are created, figuarively, out of thin air. By this, I mean that the extension of thin-air credit does not necessitate anyone cutting back on their current spending in order to extend this credit. You can think of the creators of thin-air credit, the Fed and depository institutions, as legal counterfeiters. Plotted in Chart 1 are the annualized percent changes in quarterly observations of thin-air credit (the blue bars) and the annualized percent changes in the quarterly observations of output produced by the business sector (the red bars).

  • It is almost December 23rd and that means that Festivus is nearly upon us. (Actually, Festivus is floating holiday that can be observed whenever one chooses to.) It is traditional on Festivus to air one’s grievances. Among the many, one of my grievances this year with the Fed is that it talks too much – talks too much about things of which it does not know. By talking too much, the Fed adds unnecessary volatility to the global financial markets.

    It was not always this way. In fact, there was a time when I believe the Fed talked too little. In 1986, I transitioned from being an economist at the Chicago Fed to becoming a so-called Fed-watcher at The Northern Trust Company. Back then, about the only thing the Fed publicly announced about current and future monetary policy was the dates of its Federal Open Market Committee (FOMC) meetings. If the FOMC decided at a meeting to change the desired level of the federal funds rate, it did not reveal this to the public. One of the tasks of a Fed-watcher was to divine whether the FOMC had changed its target federal funds rate. If the federal funds rate were trading somewhat above its pre-FOMC-meeting level in the days following the meeting, how did the New York Fed trading desk respond? Did it execute overnight repurchase agreements, term repurchase agreements, outright open market purchases of securities, do nothing or exercise the “nuclear” option, by executing a matched-sale-purchase agreement (today known as a reverse repurchase agreement). These different open market operations might, or might not, have different implications regarding the FOMC’s federal funds rate decision at its latest meeting. It might take several days for us Fed-watchers to determine the FOMC’s decision. And sometimes we, collectively, got it wrong. Similar to a tree falling in a forest without anyone hearing it, what if the FOMC changed its target level of the federal funds rate and Fed-watchers did not discover it? I always thought that this unnecessary secretiveness on the part of the Fed was a Fed tool to provide full employment for economists. Finally, beginning in 1994, the FOMC began announcing changes in its policy stance, and in 1995 it began to explicitly state its target level for the federal funds rate. Miraculously, many of us Fed-watchers managed to stay employed. We could now devote more of our time to trying to discern the implications of the FOMC’s latest change in the federal funds rate for the behavior of the future behavior of the economy, both in real and nominal terms, of future interest rate levels and of future foreign exchange rates. Even with the extra time available for this, we were not very good at this. But most of us continued to stay employed in our chosen profession!

    Now, the chairperson of the Fed holds a press conference immediately after the adjourning of an FOMC meeting. The chairperson talks about all manner of things entering into the FOMC’s policy decision. Not only does the chairperson announce the FOMC’s current target federal funds rate level, but also the FOMC’s expected future path of the federal funds rate. I believe it is a Herculean task to identify the “correct” current level of the federal funds rate, much less the “correct” future level of the federal funds rate. In between FOMC meetings, there can be as many as 19 Fed officials – 7 Fed Board governors and 12 Fed District Bank presidents – commenting on current and expected future monetary policy decisions, not all of whom are singing from the same hymn sheet. The current surfeit of Fedspeak brings to my mind the 1960 pop tune performed and co-written by Joe Jones, “You Talk Too Much” (check it out on YouTube). With apologies to Joe Jones and Reginald Hall, I have substituted my lyrics with Fed references to their song below.

    The Fed Talks Too Much Lyrics by Paul Kasriel To the melody of “You Talk Too Much”

    You talk too much. You worry markets to death. You talk too much. Why don’t you save your breath?

    You just taw-aw-aw-aw-aw-awk, Talk too much!

    You talk about a neutral rate That you don’t know. You talk about a soft landing Wherever you go.

    You just taw-aw-aw-aw-aw-awk, Talk too much!

    You talk about max employment That you can’t define. You talk about a terminal rate That changes all the time.

    You just taw-aw-aw-aw-aw-awk, You talk too much.

    You talk about transitory inflation And then your views shift. You talk about anchored expectations And then they begin to drift.

    You talk too much. You worry markets to death. You talk too much. Why don’t you save your breath?

    You just taw-aw-aw-aw-aw-awk, Talk too much!

    Well, I have brought the aluminum Festivus pole up from the basement. It is made of aluminum because of its high strength-to-weight ratio. And the clock in the bag is hung on the wall. Why is a clock in a bag hung on a wall? No one really knows. It’s just an ancient Festivus tradition. So, it is time to gather around the pole, lift a glass of single-malt scotch, (Lagavulin, if you are thinking of a present for me) and join in the singing of “O Festivus”. Remember, Festivus is not over until Chairman Powell pins me.

    O’ Festivus Lyrics by Katy Kasriel To the melody of O’ Tannenbaum

    O’ Festivus, O’ Festivus, This one’s for all the rest of us. The worst of us, the best of us, The shabby and well-dressed of us. We gather ‘round the ‘luminum pole, Air grievances that bare the soul. No slights too small to be expressed, It’s good to get things off our chest. It’s time now for the wrestling tests, Feel free to pin both kin and guests, O’Festivus, O’ Festivus, The holiday for the rest of us.

    And a contentious Festivus 2022 to all.

    Note: I asked ChatGPT to write lyrics for “The Fed Talks Too Much” and “O’Festivus”. In my opinion, the results fell short of versions written by lyricists Katy and Paul Kasriel. But why don’t you give ChatGPT it a try and judge for yourself?

    Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  • In the November 25, 2022 edition of Barron’s, Randall Forsyth penned an article entitled “Another Reason a Quick End to the Fed’s Rate Hikes Looks Unlikely (emphasis added). One of the reasons Forsyth advanced for his forecast (?) of future Federal Reserve interest-rate policy is the behavior of commercial bank credit. “…Joseph Carson, former chief economist at AllianceBernstein, points out that bank credit growth is booming. Loans to businesses and consumers, and for real estate, are accelerating at the fastest pace since 2008, he writes in his blog on LinkedIn.” Earlier in his article, Forsyth says “… [g]rowth in the M2 [money] measure, which consists of currency, checking, and other transaction and retail savings accounts, has collapsed to about 2% below the level a year ago. That’s a stunning reversal from the explosion in the money supply from pandemic monetary and fiscal stimulus; year-over-year, M2 expansion peaked at 27% in early 2021.” Forsyth goes on “… the contrast between the sharp slowing in M2 (which went negative, on a month-to-month basis, in September and October) and strong expansion in credit is puzzling. What should be done about this?” Earlier in the Forsyth article he cites Nancy Lazar, the veteran economist who heads macro research at Piper Sandler, “… [t]he slowing in money growth is the good news. The bad news is that M2, at $21.4 trillion, is still very elevated, by about $4 trillion over where she estimates it would be had it stayed on its prepandemic growth track.” This implies that the private sector has a lot of cash in reserve to fund spending even if the rate of growth in cash has slowed. Veteran economist and former chief economist at The Northern Trust Company, yours truly, discussed the implications of the large amount of cash held by the nonbank private sector in two commentaries, “Households’ Extraordinary Cash Holdings Will Thwart Fed Tightening” (March 14, 2022, LinkedIn, or “Viewpoints” section of Haver.com)) and “Households, Corporations and Banks Are in Good Shape as Recession Looms” (October 17, 2022, LinkedIn or “Viewpoints” section of Haver.com). If the nonbank private sector is now so flush with low/no-yielding M2 balances, why are they borrowing from banks at elevated loan rates? Is that a sign of private sector strength?

    Let’s do some fact checking before arguing that there is reason to believe that a quick end to the Fed’s rate hikes looks likely based on the recent behavior of bank credit. Plotted in Chart 1 are month-to-month annualized percent changes in both bank credit, which includes loans, leases and securities on the books of commercial banks, and the monetary aggregate, M2. Yes, M2 growth slowed in the waning months of 2021 and M2 has been more or less contracting starting in April 2022. But notice that bank credit growth has slowed since December 2021 and bank credit has contracted in both September and October 2022. So, although the magnitudes of recent month-to-month percent changes in M2 and bank credit have differed, the trends are similar – smaller positives transitioning to negatives. So, from where does the notion of “booming” bank credit come?

  • One of the worst courses I took in undergraduate school was an introduction to management “science”. The only thing I remember from that class is that if one has responsibility for some outcome, one should have the authority to influence that outcome. As we approach the midterm elections, the Republicans are holding the Democrats responsible for the higher inflation that has been experienced in the past two years. The Republicans claim that the high inflation is primarily due to the rapid growth in federal government spending implemented by President Biden and his fellow congressional Democrats, forgetting that a sizeable increase in government spending occurred on the watch of President Biden’s Republican predecessor. Perhaps President Nixon was correct when he exclaimed that we are all Keynesians now.

    I will argue, however, that Federal Reserve monetary policy is primarily responsible for the behavior of inflation, not federal government spending. If this is true and the executive and its political party are going to be held responsible for the rate of inflation, then it follows from Management 101 that the executive branch should have the authority to manage monetary policy, not the semi-autonomous Federal Reserve. My wife did not coin the term “econtrarian” to describe me for nothing.

    Let’s go through the verbal argument as to why monetary policy, not fiscal policy has the primary influence on the behavior of the inflation rate. If the government increases spending, from where does the funding of this new spending come? It comes from either an increase in taxes or an increase in securities issuance, i.e., borrowing. If taxes are increased, some entities, on net, must decrease their current spending. (There is the possibility that entities could deplete their cash holdings to make their increased tax payments, but generally this would be de minimis.) So, an increase in taxes to fund an increase in government spending would result in approximately a net zero increase in aggregate spending in the economy. The government would spend more; the private sector would spend less. Thus, a tax-financed increase in government spending would not lead to a net increase in aggregate demand, which, in turn, would not put upward pressure on the rate of inflation. The same result would obtain if the increase in government spending were financed by an increase in securities issuance to the nonbank public. To pay for the new issues of government debt purchased, just as was the case for increased taxes due, the nonbank public would have to cut back on their current spending. Thus, a securities-financed increase in government spending would not lead to a net increase in aggregate demand, which, in turn, would not put upward pressure on the rate of inflation. If foreign entities were to purchase the increased amount of government securities, they would have to cut back on their purchases of US exports because there has been no increase in their US dollar holdings. Foreign entities would purchase more US bonds and fewer US-produced Buicks. In sum, there is no logical reason to expect a tax-financed or a securities-financed increase in government spending to lead to a net increase in aggregate spending or an increase in the inflation rate. (Perhaps I am the lone non-Keynesian left.)

    Let’s look at some data. Plotted is Chart 1 are the year-over-year percent changes in the annual average of calendar year nominal U.S. government expenditures and the year-over-year percent changes in the annual average All-Items CPI from 1960 through 2021. The growth in U.S. government expenditures is lagged by two years because this yielded the highest correlation coefficient between the two series, 0.51 (shown in the little box in the upper left corner of the chart). Lagging changes in government spending by two years means that the inflation rate this year is associated with the change in government spending two years prior. Remember, if the two series moved in perfect tandem, the correlation coefficient would have a value of 1.00. So, there does appear to be some positive relationship between changes in government spending and the inflation rate.

  • To quote Mark Twain, "The report of my death was an exaggeration." I just have not had anything to say that tickled my fancy as I have watched the Fed drive the US economy toward a recession, which I think will commence in Q1:2023, as it tries to compensate for the policy error it committed in 2020-2021. Although I believe a 2023 recession is inevitable, I also believe that it will be a relatively mild one because the latest data available suggest that the balance sheets of households, nonfinancial corporations and commercial banks are in good shape. Admittedly, the latest data available are somewhat dated, being Q2:2022 for households and nonfinancial corporations and Q1:2022 for commercial banks.

    Let's start with households. Plotted in Chart 1 are quarterly values of domestic deposits plus money market funds held by households as a percent of the dollar amount of household loans outstanding. As of Q2:2022, household deposit/money market fund assets were 101.0% of the amount of their outstanding loans. In Q4:2007, the peak in the business cycle before entering the Great Recession, this ratio was only 57.0%. Thus, households are cash rich as we slip into the next recession.

  • Senate Banking Chairman Senator Brown: This confirmation hearing will now come to order. Welcome Dr. Kasriel.

    Mr. Kasriel: Before this hearing proceeds, may I submit a correction for the record. The only Dr. Kasriel I am aware of is my deceased second cousin, Robert Kasriel, who earned a doctorate in mathematics and went on to have a brilliant career teaching that subject at Georgia Tech. I never turned in a final draft of my PhD dissertation in which I investigated an obscure Federal Reserve policy called “even-keel policy”. I was attracted to this policy because I was and still am a sailor. We sailors try to keep our craft on a relatively even keel. My research concluded that there was no discernible difference between periods in which the Fed was pursuing an even-keel policy and periods when it was not. So, I do not hold a PhD, but rather an ABD, all but dissertation. That said, I do believe that my stay at a Holiday Inn Express does qualify me for consideration to serve on the Federal Reserve Board of Governors.

    Senator Brown: Let the record show that the nominee is a mere “Mister” rather than a “Doctor”. Mr. Kasriel, I am intrigued by the written statement you submitted to this committee outlining your approach to conducting monetary policy entitled “Fed, First Do No Harm”. Could you briefly explain your thesis, not the one on Fed even-keel policy, but the one in your written statement to this committee?

    Mr. Kasriel: Mr. Chairman, I am a great admirer of the writings of the late Professor Milton Friedman. Friedman argued that economies are complex, ever-changing “organisms” of which economists do not have sufficient knowledge to regulate with any meaningful precision at a macro level. There are lags, the lengths of which can vary and are unknown with, again, any meaningful precision, between when a central bank policy action is taken and when the full effect of such action on a targeted variable will occur. Moreover, economies are subject to relatively unpredictable “shocks” such as the Covid pandemic of 2020 and the Russian army’s invasion of Ukraine on February 24, 2022. Both of these shocks had significant effects on the course of the US and global economies, the magnitudes and durations of which are not known. Friedman argued, and I believe history has borne out his argument, that the Fed often takes well-intentioned policy actions to mitigate an actual or perceived undesirable macroeconomic process only to find that these policy actions result in other undesirable macroeconomic processes. A case in point was the Fed’s flooding the US economy with liquidity when the Covid pandemic hit the US economy in March 2020. The Fed rightfully feared that Covid-induced partial shutdown of the US economy could result in massive credit defaults in the private sector and the “freezing up” of the private credit markets. The Fed’s actions prevented these consequences, but the Fed did not withdraw this liquidity in a timely manner, which has fueled the high inflation we now are experiencing. In essence, Friedman argued that well-intentioned Fed monetary policy actions tend to increase the amplitudes of business cycles. That is, Fed monetary policy actions tend to turn business expansions into booms and business slowdowns into more severe recessions. The upshot of this is that the Fed should operate monetary policy such that it first does no harm to the macroeconomy.

    Ranking Member, Senator Toomey: Mr. Kasriel, are you suggesting that the Fed should keep the federal funds rate at its so-called “neutral” level?

    Mr. Kasriel: Senator Toomey, that might be a good policy if the Fed actually knew at what level of the federal funds rate represented neutral. I would submit that the neutral level of the federal funds rate is not a constant through time. For example, when businesses perceive that capital investments will be more profitable, there will be an increased demand for credit. All else the same, the level of interest rates ought to rise. Even if the Fed were aware of this, it does not know by how much interest rates should rise. Demographics can play a role in determining the neutral level of the federal funds rate. As a population ages, households’ demand for credit will ebb as they previously have borrowed to purchase a house and durable goods. All else the same, as a population ages, the neutral level of the federal funds rate would decline. Again, would the Fed know by how much the neutral level of the federal funds rate had fallen? Will all else be the same?

    Senator Toomey, the Fed currently talks about hiking the federal funds rate “somewhat” above its neutral level in order to rein in inflation and achieve a “softish” landing. I would ask the Fed to specify what it perceives the neutral level of the federal funds rate to be under current conditions. As of June 24, 2022, the 30-day federal funds futures market contract 12 months out closed at a federal funds rate of 3.50%. Should we consider this to be the neutral level of the federal funds rate?

    I don’t pretend to know what is the neutral level of the federal funds rate. But I do know that historically, the federal funds rate tends to be above the consumer price inflation rate. Plotted in Chart 1, which I submitted to the committee, is the percentage-point spread between annual averages of the federal funds rate and the year-over-year percent change in the All-Items Consumer Price Index (the blue bars). From 1955 through 2019, the median spread was 1.24 percentage points. In 2021, the CPI inflation rate was 4.70% and the federal funds averaged 0.08%, which yielded a spread of minus 4.62 percentage points. Let’s fantasize that the CPI inflation rate slows to 3% by the end of June 2023. Based on the long-run median percentage point spread between the federal funds rate and the CPI inflation rate, the federal funds rate would be 4.24% (3% plus 1.24 percentage points). This is a higher federal funds rate than the 3.50% that was priced into the federal funds futures contract 12 months from now as of June 24, 2022. The red line in Chart 1 represents the year-over-year percent change in annual average All-Items CPI. Notice, senators, when the percentage point spread between the federal funds rate and the inflation rate is negative, the inflation rate tends to be moving higher.