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 (http://www.the-econtrarian.blogspot.com).   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 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.

  • Treasury Inflation-Protected Securities (TIPS), which are marketable securities, compensate the investor for inflation by marking up/down the principal of the outstanding security every six months by the six-month CPI inflation/deflation rate. The fixed coupon rate on the originally-issued TIPS is applied to the adjusted principal every six months. If you want to know the full skinny on TIPS, Google treasurydirect.gov. But what I want to discuss is the negative yield on TIPS starting at or about the time of Covid-induced March-April 2020 recession (the red and blue lines in the chart below.) Why have TIPS yields continued to remain negative since the Covid recession? I think the answer lies in the green bars in the chart. Each green bar represents the 24-month dollar change in Fed holdings of TIPS as a percent of the 24-month dollar change in total outstanding TIPS. In the 24 months ended July 2020, the dollar change in Fed holdings of TIPS was greater than the dollar change in total TIPS outstanding, as represented by the green bar being over 100%. The green bars have continued to be above 100% through February 2022. In recent months, the Fed has been “tapering” its purchases of securities, including TIPS. But in the 24 months ended July 2020 through the 24 months ended February 2022, the Fed has been buying all of the TIPS being issued by the Treasury and then some. With a price insensitive purchaser like the Fed buying more than 100% of the new issues of TIPS is it any wonder that the yields on TIPS have been negative? Starting any day now, the Fed is going to turn into a net seller of TIPS. TIPS yields already have moved up close to zero. When the Fed begins to sell them, TIPS yields almost assuredly will rise above zero and rise rapidly. Wonder what will happen to the yield on mortgaged-backed securities when the Fed starts to unload these too?

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

  • "Core" this and that is all the rage these days. Soon to be retiring Chicago Fed President Charlie Evans is now talking about a supercore CPI. What is that? A CPI that excludes all items that have increased in price? But I digress. The headline of the media reports of the Bureau of Economic Analysis (BEA) release of its first guesstimate of the annualized percent change in real GDP for Q1:2022 was "economy contracts by 1.4%". Oh my. Call off Fed interest rate hikes because the economy has one foot in the recession grave? I referred to this advance estimate of GDP as a guesstimate because the BEA does not yet have complete first-quarter data for net exports, inventories and residential investment. So, cool your jets. I will argue that the part of the economy that the Fed has the most influence on, real private domestic sales excluding inventories (or real private domestic final sales), apparently picked up in Q1:2022.

    The advance estimate of first-quarter real GDP was held back primarily by real net exports and the change in real inventories for which, again, March data still have not been released. Real net exports held back first-quarter real GDP by 3.20 percentage points; the real change in private inventories by 0.84 percentage points. And for good measure, real government, combined federal, state and local, retarded first-quarter real GDP by 0.48 percentage points. With defense expenditures likely to be increasing and infrastructure spending gearing up, how much longer will government expenditures on goods and services be a drag on real GDP?

    But if we look at real private expenditures for goods and services, excluding inventories, the spending most influenced by monetary policy, we find a different picture. This is just a fancy name for combined real personal consumption expenditures, real private fixed-investment expenditures, including business and residential investment. As shown in Chart 1, this measure of real aggregate spending grew at an annualized pace of 3.66% in the first quarter, up from the annualized pace of 2.57% in Q4:2021. The 2017 through 2019 median quarter-to-quarter annualized growth in real private domestic final sales has been 2.72 % (the thin blue horizontal line in the chart). So real private final demand grew in Q1:2022 faster than it grew during those pre-Covid glorious years when the US economy was great again.

    Chart 1

  • By all indications, the Fed will raise the level of the federal funds rate, currently 0.08%, by 25 basis points on Wednesday, March 16. This will likely be the first of series of Fed rate hikes this year. (As this is being written, March13, the 12-month Federal Funds futures contract has priced in a rate of 1.87%. Later in this commentary I will explain why I do not believe the Fed will hike this much in this time period. When Fed Chair Powell is replaced by the reincarnation of Paul Volcker, then we will see more aggressive federal funds rate increases.) Two years ago, when Covid began spreading here, the federal government began handing out money to the bulk of American households, whether or not their incomes were adversely affected by Covid. Where did the federal government get this money to hand out? A lot of it came from the “printing presses” operated by the Federal Reserve and the banking system. And households still hold a lot of this Covid money. This means that as households face rising prices for essentials such as food and gasoline, they will be able to rundown their cash holdings to pay the higher prices without having to cut back on their purchases of discretionary goods and services as they otherwise would. These excess cash holdings by households will blunt the effects of the initial Fed rate hikes.

    The red bars (mass) in the chart below represent the sum of currency, plus checkable deposits plus money market fund shares held by households. These cash holdings skyrocketed beginning at the end of Q1:2020. The blue line in Chart 1 represents this cash held by households as a percent of their after-tax income. This ratio also has skyrocketed, reaching a post-World War II high of 154% by Q4:2021. Think of the blue line as the inverse of the velocity of money.

  • Now that the cognescenti have judged that goods/services price inflation has transitioned from transitory to something more persistent, the Fed has signaled that it is ready to start raising its main policy interest rate, the federal funds rate, at the mid March FOMC meeting. Moreover, the Fed has suggested that a March interest rate hike will be one of several this year. By how many basis points will the Fed raise the federal funds rate this year from its current level of 0.08%? No one knows, especially the Fed. The federal funds futures market is currently priced to suggest a cumulative 150 basis point rise in the federal funds rate over the next 12 months. But just as Fed policy is "data dependent", so is the federal funds futures market. However many basis points the Fed raises the federal funds rate over the next year, it will have a fiscal effect. That is, it will contribute to an increase in federal outlays in the form of higher net interest payments. Higher Treasury debt-servicing expenses imply higher future federal budget deficits, all else the same.

    The blue bars in Chart 1 are the fiscal year values of Treasury net interest expenditures as a percent of total federal outlays. The blue bars in the shaded area from fiscal year 2022 through 2031 are baseline forecasts made by the Congressional Budget Office (CBO) in July 2021. CBO baseline projections of budgetary variables incorporate current laws pertaining to the federal budget and the CBO's estimate of economic variables that would have an impact on budgetary variables. Also plotted in Chart 1 are the actual and CBO-forecast fiscal year average values of interest rates for the three-month Treasury bill (the green line) and the 10-year Treasury note (the red line). In FY 2021, Treasury interest expense as a percent of total federal outlays was 4.8% -- the lowest percentage in the period starting FY 1965. Given that federal debt held by the public increased by $6.2 trillion in the two fiscal years ended 2021, this low ratio of Treasury debt service expense relative to total federal outlays is remarkable. Of course, extremely low interest rates on Treasury debt played a major role in reducing debt-servicing costs relative to total federal outlays. More on this in a moment.

    Chart 1

  • 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. And this Festivus, I got a lot of problems with you people. My problems with you mainly concern inflation – the cause of it rather than the description of it. Related to this is the incorrect, in my opinion, assumption made by the media and many economists that increased government spending causes higher inflation. In addition I have a problem with the media reporting that the headline number of an economic release was higher/lower than economists expected.

    The faster rise in consumer prices began to be noticed in the spring of this year. Rather than discussing the cause, economists and the media tended to describe the faster increases in various consumer price indices. For example, the rate of consumer price inflation was increasing because used car prices were racing ahead. And if were not increases in used car prices one month resulting in an increase in a consumer price index, it might be restaurant meals the next month. This reminds me of President Calvin Coolidge's "analysis" of unemployment, to wit, "[w]hen more and more people are thrown out of work, unemployment results." I suspect Cal wished he had been silent on this one. But this was the initial "analysis" of rising consumer price inflation this past spring. Inflation went up because the price of this or that item in a price index went up. This is merely a description of an increase in price inflation.

    Then soon we had new definitions of "core" inflation such as all items excluding the prices of food, energy and used cars. In other words, if we exclude items with rising prices, higher inflation rates vanish. In December 2021 energy prices have fallen, which likely will moderate the rate of increase in consumer price indices. I wonder if a new "core" definition will be trotted out, this one including energy prices but excluding shelter costs.

    In my opinion, the concept of "core" inflation has done a lot to discredit economists. Fed Chairman Arthur Burns is responsible for its inception. In 1973, the global economy suffered two negative supply shocks – the failure of anchovies to show up off the coast of Peru, which indirectly caused a sharp increase in animal protein prices, and OPEC's decision to cut oil production. Chairman Burns asserted that the increases in food and energy prices were not caused by his management of monetary policy. He was right about food prices; not so much about energy prices. In August 1971 the Nixon administration discarded the 1944 Bretton Woods international monetary arrangement whereby the US dollar was fixed to gold at a price of $35 an ounce and other foreign currencies were tied to the US dollar at fixed rates. So, an era of floating exchange rates was entered into after August 1971. Leading up to and after the 1971 Nixon "shock", Burns oversaw an explosion in the growth of thin-air credit (the blue bars in Chart 1). The foreign exchange value of the US dollar collapsed after the Nixon "shock", as illustrated in Chart 1 by the decline in the US dollar vs. the German D-mark (the red line). What does this have to do with the price of oil? OPEC was receiving US dollars for its sales of oil, US dollars that were declining in terms of purchasing power. In an attempt to restore the purchasing power for the US dollars it was receiving for its oil sales, OPEC raised the US dollar price of their oil by cutting production. And, oh yes, there was the matter of a war between Israel on one side, Egypt and Syria on the other side in October 1973, after which OPEC imposed an embargo on oil sales to countries viewed as Israeli allies. Whether the Yom Kippur War was the real reason for the OPEC embargo or just convenient cover for the action could be debated, as I am sure it will be in comments to this epistle. Why not? ‘Tis the season to air one's grievances.