It is now widely expected that the Federal Reserve will begin tapering at the end of this year or early next year, with a process of raising interest rates in due course once quantitative easing (QE) has stopped. However, with the current development of the COVID-19 pandemic, this policy expectation is likely to be adjusted as the U.S. economic recovery slows.
While inflation, one of the Fed's policy objectives, remains at historically high levels, employment, another policy objective, has failed to recover effectively. The current state of employment and inflation is creating a complex situation for the Fed, which also makes its policy attempts under the Modern Monetary Theory (MMT) constantly face various criticisms. Whether the Fed will continue its policy attempts under the MMT or return to "normalizing" monetary policy is becoming a major concern of the market and economists. This will not only affect the structure and direction of the U.S. economy, but also bring new changes to the global capital market and the global economy.
Prior to the outbreak of the pandemic, many policy officials and market participants took a more reserved attitude towards monetary policy under the MMT. Whereas, COVID-19 did give the Fed an opportunity to practice monetary policy under the MMT. On the one hand, the Fed has established a new policy framework of average inflation targeting. On the other hand, the Fed has once again purchased massive amounts of U.S. Treasuries through quantitative easing to support the U.S. government's massive stimulus program. From the perspective of the Fed's current policy, although its officials do not admit that they practice the policy framework of MMT, its actual operation is getting closer to the fiscal monetization advocated by MMT.
The Fed's quantitative easing is a far cry from that during the 2008 financial crisis. At that time, the liquidity released by the Fed through quantitative easing was mainly in the form of credit and equity. It can be said that this is the responsibility of the central bank as the lender of last resort. The expansion of the Fed's balance sheet is mainly to play the monetary regulation function and increase the money supply to make up for the liquidity gap, so as to further support the financial system and economic operation. After the COVID-19 outbreak, the U.S. government has played a leading role in bailing out the market and households. By expanding fiscal spending, the government has not only purchased large amounts of assets, but also directly promoted the increase of corporate credit and provided relief funds to households. As a result, the role of fiscal support for liquidity increases, hence government debt increases, while the role of the central bank become secondary. This mode has more characteristics of MMT.
The increase in government spending to stimulate economic recovery has further increased the government debt and brought it close to the U.S. debt ceiling, while the massive amount of money spent has also led to a rise in the price level. Researchers at ANBOUND have suggested that there are no worries about the U.S. debt problem. In the era of credit money, the U.S. government's credit can still rely on its dominant position in the global currency to continue to expand. Instead, it is inflation that will affect the direction of the U.S. economy and policy.
The Fed and some market participants have different views on whether inflation is caused by an excess supply of money. The Fed has repeatedly emphasized that inflation is a temporary situation, a consequence of a post-pandemic rebound in demand, and a temporary imbalance in supply amid distortions in global supply chains. As the outbreak is contained and economic order is restored, the Fed insists that inflation will gradually moderate in the future. Despite differing views on inflation, inflation remains a key factor affecting U.S. monetary and fiscal policy.
U.S. economic growth slowed slightly in August due to the resurgence of COVID-19, the Fed said in its Beige Book released on September 8. This more than expected change could mean that inflationary pressures will abate as demand slows, allowing the Fed to continue its current easing under the MMT. At the same time, the new U.S. administration is pushing for new stimulus programs that will further expand government spending and raise government debt levels. If these stimulus programs are implemented, the government's dominant role in the economy will be further strengthened.
However, even under the Fed's easing policies and the U.S. government's stimulus measures, the U.S. economy has still not been able to achieve the expected rapid recovery. This is an embarrassment for MMT advocates. The Fed's report showed a patchy recovery in U.S. employment, with hiring and wages rising and a large number of unemployed people still looking for jobs. While some believe that the U.S. government's subsidies have reduced incentives to get people back to work, the imbalance in employment also indicates serious distortions in the structure of the economy and employment. These conditions will further fuel inflation and slow the pace of economic recovery.
The tendency of stagflation exhibited by the U.S. economy is one of the reasons for the criticism of MMT. Critics argue that MMT would have the same consequences as Keynesian policies. Of course, the U.S. government is also trying to make up for the fiscal gap by raising taxes, as advocated by the MMT. For some time to come, more attention will be paid to whether this money cycle works. If the Fed continues quantitative easing on the grounds that the economy has not fully recovered, and inflation starts to moderate in the future as it expects, the MMT attempt will be a phased success. On the contrary, if inflation gets out of control, the Fed will have to accelerate the pace of its exit from easing and even reduce its balance sheet in response, thus ending its attempt of MMT policy.
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