Tags: Fed | inflation | money | assets

Fed Needs to Back the Money Supply With Real Assets

By Barry Elias   |   Friday, 01 May 2015 08:20 AM

Despite having a dual mandate to keep inflation and unemployment at low sustainable levels, the Federal Reserve has left the masses in the dust since the late 1970s.

After adjusting for inflation, average household income for the middle fifth rose only 20 percent from 1979 through 2007. During the same period, average real income for the top 1 percent skyrocketed almost 245 percent, according to the Economic Policy Institute.

Why such a disparity?

The Fed has focused on lagging indicators, such as inflation and unemployment. This is extremely difficult for them to manage monetary policy effectively, since it is reactive. Further, unemployment involves fiscal policy measures, such as spending and taxing, which the Fed lacks the authority to address.

The debate about inflation targets becomes less relevant, especially since the Fed's measure of inflation may not be accurate in the first place.

In 2000, the Fed began using a different measure of inflation. The Personal Consumption Expenditure Price Index (PCEPI) replaced the Consumer Price Index (CPI). The PCEPI is a measure of expenditure increases, not price level increases. As prices rise, consumers typically purchase less-expensive items, thereby limiting their spending. This essentially understates the real level of inflation.

Since 1960, the Fed estimates the PCEPI is approximately 22 percent lower than the CPI is.

Making matters worse, in 2012 the Fed set an inflation target rate of 2 percent for the core PCEPI. "Core" implies that food and energy purchases are excluded, despite being an important component of household budgets.

The Fed would better serve society by backing the money supply with real assets. Real assets are produced by an efficient utilization of resources with price levels determined by market forces rather than a centralized authority. Money would be created at a rate that could be absorbed by demand. The cost of producing the money would then be transmitted to the remainder of the economy in a more stable manner.

If the Fed prints a dollar, they need to be certain that at least 10 cents are represented by real assets. This is similar to sound financial institutions holding adequate capital reserves to protect against market price moves and cash withdrawals.

The Fed needs to focus on tying the money supply to the production of goods and services. This would generate greater investment, employment and economic growth while keeping inflation in check. More money and less inflation would mean greater purchasing power for the general population.

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Elias
Despite having a dual mandate to keep inflation and unemployment at low sustainable levels, the Federal Reserve has left the masses in the dust since the late 1970s.
Fed, inflation, money, assets
406
2015-20-01
 

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