Road to Hyperinflation is paved with Market Accommodating Monetary Policy

By Henry C.K. Liu,

Part I: A Crisis the Fed Helped to Create but Helpless to Cure

After months of denial to sooth a nervous market, the Federal Reserve, the US central bank, finally started to take increasingly desperate steps in a series of frantic attempts to try to inject more liquidity into distressed financial institutions to revive and stabilize credit markets that have been roiled by turmoil since August 2007 and to prevent the home mortgage credit crisis from infesting the whole economy.

Yet more liquidity appears to be a counterproductive response to a credit crisis that has been caused by years of excess liquidity. A liquidity crisis is merely a symptom of the current financial malaise. The real disease is mounting insolvency resulting from excessive debt for which adding liquidity can only postpone the day of reckoning towards a bigger problem but cannot cure.

Further, the market is stalled by a liquidity crunch, but the economy is plagued with excess liquidity. What the Fed appears to be doing is to try to save the market at the expense of the economy by adding more liquidity.The Federal Reserve has at its disposal three tools of monetary policy: open market operations to keep fed funds rate on target, the discount rate and bank reserve requirements.

The Board of Governors of the Federal Reserve System is responsible for setting the discount rate at which banks can borrow directly from the Fed and for setting bank reserve requirements. The Federal Open Market Committee (FOMC) is responsible for setting the fed funds rate target and for conducting open market operations to keep it within target. Interest rates affects the cost of money and the bank reserve requirements affect the size of the money supply. FULL ARTICLE