John Plender (The Long View, May 7) is not alone in believing that “the rate of interest,” as measured by bond yields and the central bank rate, sets monetary policy.
But the Federal Reserve’s actions on interest rates cannot explain the current surge in inflation. The federal funds rate was cut from just above 1.5% in February 2020, just before the Covid emergency, to virtually zero a few weeks later. But the move was insignificant compared to the truly inflationary 1970s, when the federal funds rate was sometimes in the double digits and its cuts sometimes exceeded 500 basis points in a year. It should also be remembered that the fed funds rate was consistently below 0.5% for the eight years to November 2016, a period of negligible inflation.
The main cause of the current rapid inflation is an extraordinary increase in the quantity of money. In the three years to the end of 2021, the broad monetary measure M3 grew by almost 45%. This figure was higher than the 33 percent increase in M3 over the whole of the previous decade.
Since the spring of 2020, too much money was chasing too few assets. Excess money has been the driving force behind the strength of the US stock market and the strength of house prices.
In February 2022, house prices were more than 42% higher than three years earlier, according to the Federal Housing Finance Agency index. In contrast, near-zero interest rates in the eight years to November 2016 were associated with an average house price increase of just 3.5% per year.
The Fed’s latest announcement of planned large asset sales signals an early collapse in monetary growth and could even lead to a contraction in the quantity of money. A severe tightening of monetary policy would then be a major concern for the asset markets.
Professor Tim Congdon
President, Institute for International Monetary Research, University of Buckingham
Buckingham, United Kingdom