E Does Neo-Fisherian Economics Cause Fed To Bark Up The Wrong Tree?

Could it be that Neo-Fisherian economics causes the Fed to bark up the wrong tree. Neo-Fisherian economics is also tied to New Monetarism. I have said before that New Monetarism has captured the thinking of the Fed. I discuss the current Fed situation and get back to the implications of Neo-Fisherian economics through Scott Sumner's insights, and my opinion at the end of the article.

So, here are issues facing the Fed:

If the Fed raises interest rates, the banks will receive the interest payments that should be remitted to the treasury, to the taxpayers! That will be a serious problem. I wrote that the Fed is predisposed to keep interest rates low. One of the reasons is this very problem, that the Fed cannot afford to pay the treasury if rates are raised. That interest will go to the banks and increase as rates are raised because of the 2.4 trillion or so dollars of reserves now held by the banks.

Well, since the Fed will have to pay the banks higher interest on reserves, the Fed cannot raise rates too high.This is why the Fed cannot let the economy grow faster. In fact, the Fed has political reasons for not being able to raise interest rates. The political reasons relate to the anger of congress if the interest, which amounts to 70-90 billion dollars per year, is not remitted. That would be stealing from the taxpayers to pay the banks. Congressmen could lose their jobs over this issue. They will go along with the cabal most times except when their jobs are at stake!

Banks have never had this level of excess reserves before, except for the Great Depression, so that raising interest rates under normal times never resulted in more money going to the banks.

And we know the Fed is afraid that if it doesn't pay the banks, the 2.4 trillion dollars of excess reserves could be loaned out at 24 trillion dollars, 10 to 1, and cause the Fed to lose its control of an overheated economy entirely. By not paying the banks, it could force the banks to lend at rates that are very low. We know what happened to the S&L's when inflation nullified the profits on their loans. The Fed cannot allow the economy to overheat with all these reserves getting in the way. Big inflation is not a likely scenario but the Fed will always protect against it. 

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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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Gary Anderson 4 years ago Author's comment

Correction, the Fed does not want to charge interest on reservers.