Arnold: The Emperor Knows He Has No Clothes
The Federal Reserve has telegraphed the intention to begin to taper its purchases of mortgage and Treasury securities and the market is pricing for that to begin in September.
The conventional neo-classical and financial market expectation is that the Fed is anticipating an increase in economic activity that warrants decreasing the monetary stimulus in order to preemptively keep from stoking inflation.
As former Fed Chairman William McChesney posited, the Fed's job is "to take away the punch bowl just as the party gets going."
Although the Fed's mandate was different when McChesney was the chairman and the dollar was backed by gold, the fundamental takeaway from such is that the removal of monetary stimulus is an indication of its success in having helped the economy over a period of contraction and to have stimulated growth again.The transmission mechanism is pretty simple: reduce the cost of debt, depreciate the currency, increase the price of financial and real assets. The increase in asset prices stimulates the "wealth effect," causing confidence and consumption to increase. That, in turn, causes production and job creation to increase. But this hasn't happened. The increase in asset prices has happened and the 1-10% of society owning the vast majority of financial assets have gotten wealthier, but they haven't created jobs. Instead, QE has resulted in more wealth concentration. It appears to me to be more logical that the Fed is signaling its willingness to begin to slow the rate of quantitative easing not because it has succeeded, but because it has failed. In other words a reverse scenario to that of "The Emperor's New Clothes" appears to be playing out, with the Fed aware that its policies have failed, but with few others aware. Neither of the Fed's dual mandates of price stability and full employment has been achieved. But the beneficiaries of the Fed's policies are apparently so busy counting their new-found wealth that they haven't had time to create jobs or are oblivious to the fact that nobody else has created them either.
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