Unwinding the monetary policy of the FRB

Professor Hamilton provides a very clear explanation of Fed activity and a neat summation of the problem:

Looking for an exit

“the current fiscal trajectory is fundamentally inconsistent with the Federal Reserve choosing to keep inflation under control. Both devices, ballooning of the Treasury’s account with the Fed and enabling the Fed in effect to borrow directly on its own, are indeed as much fiscal measures as they are monetary. But to someone worried about the increasing co-mingling of monetary and fiscal policy, that blurring of the lines is not a reassuring development.

My specific worry is that we will eventually face a crisis of confidence in the Treasury and the dollar itself. It is true, as Bernanke suggests, that raising the interest rate paid on reserves in such a setting would be a policy tool that could be used in response. But it would be an unattractive measure to the point of perhaps being impossible to use in practice, for the same reason other countries have dreaded raising interest rates in the face of collapsing real economic activity and a flight from their currency.

I fear that the United States government is mistakenly assuming that it can borrow essentially unlimited sums without undermining confidence in the dollar itself. The real question of a successful exit strategy, in my opinion, is how do we extricate ourselves from the joint fiscal commitmentscurrently assumed by the Treasury, the Fed, the FDIC, the Medicare and Social Security trust funds, and various and sundry implicit and explicit federal guarantees?”



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