HuffPo's Auerbach: Fed Has Created an Inflation 'Time Bomb'

Tuesday, 26 Nov 2013 12:27 PM

By Michael Kling

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The Federal Reserve has created a "stimulus hoax" and an inflation time bomb that may cause an economic disaster, says a University of Texas professor of public affairs.

As the Fed embarked on its stimulus endeavor, excess reserves banks hold at the Fed exploded from $1.9 billion in August 2009 to over $2.2 trillion as of September 2013, making up almost 84 percent of the monetary base, points out, writes Robert Auerbach in an article for the Huffington Post.

Banks do not pump those reserves into the economy by lending the money to consumers or businesses. Instead, they hold them as excess reserves because the Fed decided in October 2008 to pay them interest on reserve balances, Auerbach explains. Banks see that risk-free 0.25 percent rate as preferable to lending the funds out to consumers or businesses.

Editor’s Note: Opinion: Retirees to Be Hit With Social Security Cuts

But the time bomb of excess reserves may explode if inflation increases, warns Auerbach, a former economist with the House of Representatives Financial Services Committee and the U.S. Treasury's Office of Domestic Monetary Affairs.

"If short-term interest rates rise above 3 percent, the Fed may have to pay perhaps 3 percent interest on excess reserves to keep the time bomb from exploding into the economy as the banks invest in more lucrative income earning assets."

Much of that money, he predicts, would go to their stockholders due to lack of competition in the concentrated banking sector.

Some Fed officials may consider continuing increasing excess reserves as a gift to stockowners, he asserts, noting that six of the nine directors at the 12 Federal Reserve district banks are elected by banks in their districts.

The Fed, he urges, should gradually stop paying interest on excess reserves and reduce the monetary base to offset large drops in excess reserves as banks begin lending.

Minutes of their meetings suggest Fed officials are unwilling to reduce interest payments on banks' excess reserves out of fear of inflation, according to The Wall Street Journal.

"It’s very much in the Fed’s interest to control that money because if inflation ever were to reappear, it could rapidly flow into the economy and create added inflationary pressures," writes Wall Street Journal columnist Michael Casey. "Paying interest on those deposits keeps it under control."

Editor’s Note:
Opinion: Retirees to Be Hit With Social Security Cuts

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