The Federal Reserve Chairman Jerome Powell gave a widely watched speech entitled “New Economic Challenges and the Fed’s Monetary Policy Review at the Jackson Hole Economic Symposium. In his remarks, Powell announced the Fed would allow inflation to run above its long-term 2% level. More immediately, the Fed will continue with its policy of keeping the Fed funds rate at almost zero and buying Treasury bonds to the tune of $80 billion a month.
To put things in perspective, the Fed’s total assets stood at $4.3 trillion in March, and $6.6 trillion in August – a massive increase due to the purchases of U.S. Treasurys and mortgage-backed securities. It is very likely the Fed funds rate will stay at zero for a prolonged period of time – probably for the next five years. In comparison, in Japan, short rates have stayed at or below zero with a short intermission for 20 years.
In theory, the Fed’s massive money printing and the associated ballooning of its balance sheet undertaken to fight the economic impact of COVID-19 would lead to heightened inflation. In practice, inflation stays fairly low due to the global economy’s overall weakness and reduced demand. One possible explanation is that due to the high degree of economic uncertainty, both individuals and businesses tend to hoard their money rather than spend it.
In particular, banks, which under normal circumstances are eager to lend, tend to keep their assets at the Fed. Thus, commercial banks are moving away from the fractional reserve to the narrow bank model, while the Fed operates more as a fractional reserve bank. Although Powell’s announcement is of little immediate consequence, in the long term it will have profound implications for the price of equities, oil, gold and cryptos, and, more broadly, to the modus operandi of the entire financial system.