When Money Is No Longer Artificially Money

Federal Reserve Chairman Jerome Powell has decided to listen more to markets and embrace a healthy agnosticism about economics.

During his first year, the Fed increased the federal funds rate - the rate banks receive on deposits at the central bank and pay each other on overnight loans - by a full point to about 2.4 percent - and continued to run down holdings of mortgage back securities accumulated during the financial crisis.

The former strongly affects short-term business loans, credit cards, and auto rates, while the latter significantly influences the markets for long-term corporate bonds and home mortgages.

Through December, the stock market fell a record seven times in a row following Fed policy committee meetings and in a stunning vote of no confidence, dramatically after the chairman spoke in December.

Mr. Powell has backed off. He won't be raising the federal funds' rates again any time soon and has promised to be more cautious about liquidating the Fed's holdings of the mortgage-backed securities and Treasuries.

Pundits have concluded that the Fed has gone from trying to wean markets from cheap credit to promiscuity, giving the equity investors exactly what they want.

Nothing could be further from the truth - money isn't artificially cheap anymore.

Over the last decade, credit markets have changed profoundly. More supply: Sluggish growth and endemic structural woes in Europe, China and Japan have increased the dollar's role in global commerce. Consequently, foreign investors and central banks are holding more Treasuries and other dollar-denominated securities and bank deposits.

Less demand: Consumers are more cautious about credit card debt and too many of them are burdened by excessive student loans to consider too much borrowing for homes.

These combine to significantly lower the neutral rate of interest. At 2.4 percent for the federal funds rate and 4.4 percent to 4.7 percent for mortgages, the Fed has found the sweet spot for hitting its 2 percent inflation target and maintaining a solid pace of economic growth. For example, as mortgages inched up to 4.9 percent in November, new home sales tanked but as rates slipped back in December, buyers returned to the market.

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Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster ...

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Gary Anderson 8 months ago Contributor's comment

Interesting rant. Worth the read. Of course, Dec 2018 only shows manufacuring productivity growth. We still don't know what total non farm productivity growth is. There are some coming out to work who stopped looking in the low growth years of 2014 and 2015. But wage growth for this mini recovery are historically low, except for durable goods. This is still the New Normal, Peter.