personal views of a former fed trader

Stock and Flow

The stock effects of monetary tightening are clearly disinflationary, but the flow effects are less clear. The Fed’s rapid tightening markedly reduced the level of household wealth and thus potential demand, but the bulk of asset repricing seems to be behind us. The impact of tighter policy going forward is less certain because higher rates restrain some sectors but subsidize others. Interest income from reserves, RRP, and newly issued Treasuries rise along with rate hikes and can potentially increase demand. In addition, households and corporations borrowed at historically low rates and have been largely insulated from recent hikes. This post walks through the cross currents of higher interest rates and suggests the relative ineffectiveness of the Fed’s policy tools may lead to a more aggressive policy response.

Financial assets are down notably below early highs, though some asset prices remain higher than their pre-covid levels.

Stock Effect

One of the Fed’s tools to impact aggregate demand is by adjusting household wealth, which in turn impacts household spending power. Changes in interest rates directly impact fixed income assets, which then flow through to the rest of the market. The wealth effect was an explicit rationale for QE, where higher asset prices were thought to boost consumer spending. By the same logic, lowering household wealth can potentially lower consumer spending and dampen inflation. However, growth and inflation remained subdued post-GFC even as asset prices leapt higher.

Public data suggests top 20% of earners hold 70% of household wealth.

One reason for the ineffectiveness of the wealth effect could be the narrowness of its reach. Public data suggest that the top 20% of earners hold 70% of household wealth, so most households are unaffected by the wealth effect. Note there is uncertainty to this estimate as it does not include crypto, which may have a different investor profile. In a sense, a negative wealth effect is functionally a one-time progressive tax hike that may be too progressive. Consumer spending appears resilient even after large declines in asset prices, though most asset prices remain comfortably above pre-pandemic levels.

Flow Effects

Higher interest rates can restrain economic activity by increasing the cost of credit, but the impacts have so far been limited. The dampening impact can arise from slowing the rate of credit growth and increasing the interest payments of current borrowers. Housing market activity has slowed significantly as mortgage rates rose, but the overall pace of credit creation remains clearly above pre-pandemic levels. Recent surveys indicates that banks expect credit demand to wane, so a broader slowdown in credit growth may eventually materialize.

Bank lending continues to grow at an elevated rate

Households and corporate interest rate expenses have largely been unaffected from the aggressive rise in interest rates. The bulk of U.S. household debt is in the form of 30-year fixed rate mortgages, which have largely been refinanced at generationally low mortgage rates. Corporations have the highest debt servicing capacity in 20 years as their revenues rose with inflation but interest expenses were little changed. Corporations borrowed heavily when rates were low and will eventually have to refinance at higher rates, but the overall maturity schedule for them indicates that is a few years away.

Rising revenues have pushed corporate debt servicing capacity to multi-decade highs

The economic impact of higher rates is mixed because it also subsidizes consumption by increasing private sector interest income from public sector liabilities. While private sector interest expenditures merely redistribute income among private actors, public sector interest rate expenditures are financed by printing money or Treasuries (which are money like). These payments increases the overall spending power of the private sector. Public sector interest expenditures include the interest the Fed pays on reserves and the RRP, as well as interest on the trillions in Treasury securities. If rates are higher for longer, the interest payments will easily exceed a $1t next year.

Government interest rate expenditures have been rising with the level of debt.

Note that one day the level of public sector liabilities may become so large that the interest income channel dominates other channels. That may make monetary policy obsolete, or paradoxically require lower rates to dampen inflation.

What Hikes?

The aggressive rate hikes have thus far appear to have a limited effect on dampening inflation. Wages and nominal GDP are growing at around 6.5% and 9%, respectively, both rates that are very inconsistent with a 2% inflation target. Wage growth may be particularly resilient, as demographics suggest the working age population is no longer growing. With the policy rate much closer to the terminal rate than 0% and financial markets stabilizing, the stock effect of monetary policy appears to be waning. If the flow effects are mixed, then the current stance of policy may not be effective in moving inflation back to 2%. This may prompt the Fed to bang harder on the only button they have.

Atlanta Fed GDP Nowcasting suggests 4% real GDP growth in 2022Q4


  1. Chuck

    Really great book and supper article.

  2. Alex

    Hi Joseph,
    Thanks for the book, it was fascinating to read.
    With regards to the article, the stats in fact shows the resilience of the households to rising interest rates environment. However, looking into the underlying’s, household consumption does not look sustainable at this level. Americans’ personal savings have plunged to $629 billion in the second quarter of 2022. In the second quarter of 2021, they had $1.98 trillion. The personal savings rate is the lowest since 2008, and credit card debt just reached a record high. In essence, households are draining their cash piles, which they collected during the lockdown to finance the purchases and cover the interest expenses which are growing.

  3. Mark Lewis

    Looking at monetary tightening’s effects per decile of age would seem to me to shed light as well as income stratification. Families with school age children have a totally different inflation basket than a recent retiree who can forgo clothes, gadget shopping, even food and gasoline purchases relatively easily. A moderately well heeled retiree now has an extra 4% on any cash savings, along with a paid off house or 3% mortgage. She may could have more free cash flow despite less “wealth” which could in turn affect her spending habits.

  4. YB

    Thanks Joseph. Great article.

  5. Dot

    Would love to hear your thoughts on the SF federal reserve bank letter on the impact of QT…how it interacts with changes in rates to increase the level of policy restriction. Another button they are hammering on. Cheers!

  6. Anonymous

    You don’t really show or make a case for how this will all not negatively affect the real economy. I don’t see much of this wealth creation even if it is massively actually making it to the real economy…but I think you are making the argument that equities may continue to go up up and up, while the real economy is suffering?

    • JohnB

      Majority of Americans do not own Treasuries or have any savings – they live paycheck to paycheck and have no savings…Of course FED analysts, being central planners, just lump everyone together and do not recognize that people are individuals and act act based upon their own unique circumstances, of course, many are in the same sinking boat thanks to the lack of sound money and horrendous Federal Reserve policies…
      Does Mr. Wang still think equity markets will decline another 30%? What about the severe inversions we see in Government bond markets all over the world — what does that suggest about future interest income / flow effects???

  7. Unusual Whales

    Great post Joseph!

  8. Gambogi

    Perhaps excess savings explain the ineffectiveness of monetary policy.
    Let’s see when this excess evaporates.

  9. Len Ulan

    Unique perspective! I have not seen the thesis of public sector liabilities growth leading to future dominance of interest payment channels. If it does have a paradoxical effect on interest rate policy, the ramifications will be profound.
    It’s becoming clear that rates will remain high for a long time. There will be no quick rebound or V bottom. High rates and tight monetary policy will slowly grind at the margin and eventually have the desired effect. No need to hike much higher, just let time exert it’s inexorable force.

    • Spencer

      re: “No need to hike much higher, just let time exert it’s inexorable force.”

      Agreed. It’s exactly as Lawrence K. Roos, Past President, Federal Reserve Bank of St. Louis and past member of the FOMC (the policy arm of the Fed) as cited in the WSJ April 10, 1986:

      “…I do not believe that the control of money growth ever became the primary priority of the Fed. I think that there was always and still is, a preoccupation with stabilization of interest rates”.

  10. G Gervin

    There’s rates, off of ZIRP, then there’s QE. QE/QT is where the real action is vis a vis the wealth effect. No one discounts real estate, stocks, etc using the FF rate or 3 month bills as the RFR.

    Shrink the balance sheet, get the belly of the curve higher – both with QT and a higher terminal rate (needed given the inversion that will ensue ) – and thereby destroy (some fictitious) wealth….this will reduce inflation

    It’s pretty simple

  11. Andre3k

    Hustle and flow

  12. Richard H

    Great thinking again.
    However, Joseph, I read your book “C. Banking 101” and, although everything else made sense, pg 193 about QE seems patently wrong:
    “purchasing Treasury Securities by printing central bank reserves was like printing a $100 bill and using it to buy another $100 bill. The amount of money in the system didn’t change, just the commposition of it. There were now fewer Treasury securities and more central bank reserves”
    But there are not fewer Treasury securities just because the Fed owns them.
    And there were more dollars, even if only reserves or “outside” money.
    Can you please comment on this. Thanks.

    • Joseph Wang

      The Treasuries are no longer available to the private sector, it is as if they no longer exist. Fed holds them until maturity. Private sector has fewer Treasuries and instead more cash.

      • Amit Hampel

        That is incorrect JW. The treasuries are indeed available to the public through the Reverse RP program. The stock of treasuries is funneled back into the market in the form of collateralized loans to the banking system. It seems to me to reverse the inflationary impetus that was created by handouts and PPP forgiven loans is to enact a tax increase to recoup the free money handed over by the Trump years and then multiplied 10x by the Biden administration. The other necessary elixir is to actually enact QT – sell some of the stock of treasuries and/or MBS. That would essentially shrink the monetary base.

        • Joseph Wang

          The MMFs receive Fed treasuries as collateral, but just sit on it. They are not able to repledge or anything – it does not involve the banking system and more technically just sits on the triparty platform. It is much more useful to think of the RRP program as a interest bearing deposit account for MMFs.

  13. Richard H.

    Thanks for replying Joseph.
    I am almost beginning to think though that their is some wierd conspiracy to change mathematics/logic.
    Whether the Treasuries are still available to the private sector or not does not matter – unless I am going crazy; the point is that the Fed is buying Treasuries from the Treasury (through the dealers), and the Fed is doing this with new money (that did not exist before their purchases). How can this not be inflationary?
    (my only assumption here is that the dealers do not need private money to make their initial purchases – other than the small percentage required to finance Treasury operations. I am not sure what this percentage is, but I thought it was something like 10X leverage. So the other 90% would in effect be coming from the Fed)

    • JohnB

      “the Fed is buying Treasuries from the Treasury (through the dealers), and the Fed is doing this with new money (that did not exist before their purchases). How can this not be inflationary?” This is monetization of Gov Debt by the Fiat Banking Cartel, no?
      It is absolutely inflationary to the size of the Federal Government and this is not good – “Government is by definition an inherently inefficient, wasteful, and coercive territorial monopolist of ultimate decisionmaking & violence…Governments and everyone on their payroll live off the loot stolen from other people. They lead a parasitic existence at the expense of a subdued and “host” populace.“
      Maybe, just maybe, this explains the destruction of living standards, the massive inequality via Cantillon effects, the severe loss of individual Liberties, the enormous growth of the Military Industry Complex, So many people dependent on Government, etc etc etc…The one thing that has grown enormously/inflated is Government!

    • Dan S

      I had the same issue, but upon thinking and re-reading, I think Joseph has it exactly right. But, there are 2 underlying assumptions: First, we are taking the viewpoint of the private sector. Second, Treasuries, although not officially part of M2, are absolutely “money” if you are a large corporation or wealthy individual. Those entities don’t leave their money in a bank checking account – they buy short term treasuries which are highly liquid and can be converted quickly to cash. So, for all practical purposes for these actors, treasuries are money. If you can get to this conclusion, it changes your perspective.

      So, when the Fed buys treasuries and credits bank reserves, in the private sector this means someone gave up their treasury (lost one type of money), and now has a bank deposit (another type of money). If you look at these types of money as very similar, then Joseph is absolutely right. You have just changed one type of money for another, and it won’t change spending patterns.

      If you think that having a bigger bank account balance and an offsetting lower treasury bill balance in your brokerage account will change spending / behavior of the private sector, then you will believe this constitutes “monetization” and inflation may be coming.

      I used to believe this model, but the empirical evidence post the financial crisis, and in Japan, showed me there could be massive purchases of treasuries, (i.e. monetization), but without inflation. And it is because there is not more money, but more of one type of money (bank deposits) and less of another type of money (treasuries).

      Said more directly: Do you think a corporation or wealthy individual will change their spending patterns because now they hold $1 million in a bank account instead of $1 million of treasuries? I don’t think so. In fact, we all know QE did not lead to inflation.

      Anticipating a rebbutal: But, inflation did occur with the latest QE during COVID! But, two differences: One, is supply constraints. The other is that the money actually went to lower income people who spent it (rather than wealthy people and companies that saved it).

      • Spencer

        M2 is mud pie. Link: George Garvey:
        Deposit Velocity and Its Significance (

        “Obviously, velocity of total deposits, including time deposits, is considerably lower than that computed for demand deposits alone. The precise difference between the two sets of ratios would depend on the relative share of time deposits in the total as well as on the respective turnover rates of the two types of deposits.”

  14. Spencer

    Shows how QE impacts asset prices. But the modeling excludes commercial bank credit, just related to Reserve bank credit.

  15. Spencer

    M2 hasn’t changed for c. 1 year. But DDs have risen. I.e., the composition of M2 has changed. So, the “demand for money” has fallen, and thus velocity has risen. So, short-term money flows are rising at the same time long-term money flows are falling. Until short-term money flows reverse, a recession will not happen.

    07/1/2022 ,,,,, 0.088
    08/1/2022 ,,,,, 0.124
    09/1/2022 ,,,,, 0.072
    10/1/2022 ,,,,, 0.069
    11/1/2022 ,,,,, 0.087
    12/1/2022 ,,,,, 0.091
    01/1/2023 ,,,,, 0.097 Xmas bulge?
    02/1/2023 ,,,,, 0.094
    03/1/2023 ,,,,, 0.101
    04/1/2023 ,,,,, 0.128

  16. Spencer

    I.e., long-term money flows, the volume and velocity of money, the proxy for inflation, is falling, while short-term money flows the proxy for real output is rising.

    07/1/2022 ,,,,, 1.195
    08/1/2022 ,,,,, 1.28
    09/1/2022 ,,,,, 1.143
    10/1/2022 ,,,,, 1.094
    11/1/2022 ,,,,, 0.851
    12/1/2022 ,,,,, 0.564
    01/1/2023 ,,,,, 0.588
    02/1/2023 ,,,,, 0.529
    03/1/2023 ,,,,, 0.446

    This is confirmed by Atanta’s gDpnow @ 4.3% and Cleveland’s CPI inflation nowcast @ 5.14%

  17. Richard H

    Thank you Dan S.
    I understand the exchangability of treasuries and money. But that is not what is happening.
    The Fed is not exchanging existing money for treasuries, it is creating new money out of thin air to exchange the treasuries. There is more money (Reserves)and the same amount of treasuries. The Reserves, in turn, create Private, Bank money, although maybe not immediately one for one.
    Now, as to why there has been no inflation, whatever the reason, it does not negate the math/logic of the above. We have not had inflation for many reasons, but probably paramount is the productivity increases because of technology – even if productivity figures are not borne out by government imperfect studies, common sense tells us how much more productive we have become because of the smart phone, etc.!.
    Looking at it another way, think of the deflation we would have had if the Fed had not inflated Reserves. Higher productivity = deflation. This has been offset for years now by the Fed’s inflationary printing. We got lucky, then – and so did Japan (for other reasons in addtion to tech – ageing population) – because the productivity gains masked the inflationary Fed efforts. But it is not lucky; the whole value of productivity should have been the dollar worth more! – gradual deflation.
    Joseph or Spencer, I would really appreciate if you would weigh in on this.

    • Spencer

      No expert in that area. But: As DR. Ravi Batra pointed out in his book: “Greenspan’s Fraud”:

      “If demand and supply are to be balanced over time, then either wages rise in sync with productivity, or productivity growth must be matched by the growth of wages plus debt…so debt growth was the only way to maintain demand-supply equilibrium from the 1970s till today.”

    • Dan S

      Thanks Richard H.

      I agree with most of your statements, including the first and third sentences of your second paragraph. Where I disagree is your 2nd sentence in 2nd paragraph: “and the same amount of treasuries”. Yes, by definition, treasuries are still in existence and there is the “same amount” (and there are more bank reserves).

      But, take the viewpoint of ONLY the private sector. For the private sector, the treasuries are not available – they are now on the Fed’s balance sheet. They have been removed from the private system. They are not traded. They cannot be purchased.

      Empirical case in point: In Japan, where the BOJ has purchased a huge percentage of Japanese Government bonds (JGB), there are some days were JGBs have not traded! Or, the volume has been extremely low. This is because the number of bonds left to trade (not on the BOJ balance sheet) has been drastically reduced. Just of way of showing that the private sector no longer can access the JGBs on the BOJ’s balance sheet – just like the private sector in the US cannot access the treasuries on the Fed balance sheet.

      This is all a long way of saying, QE is substituting one type of money (bank deposits) for another type of money (treasuries) – from the perspective of the PRIVATE SECTOR.

      Do this thought experiment: What if the Fed, tomorrow, purchased all the outstanding treasury debt, put it on their balance sheet, credited bank reserves, and said, “that’s it, we are keeping this on our balance sheet and leaving it there until it matures.” What would happen? Well, the primary dealers would have tons of bank deposits. And no treasury holdings. Pure substitution of one type of money for another.

      That then starts the “portfolio rebalancing effect” a key transmission mechanism for monetary policy. Everyone with these low yielding bank deposits says, “I used to hold treasuries that paid interest, how can I now get extra yield?” So, the prices of other bonds are bid up (credit spreads tighten), banks start to lend at lower rates, etc. Inflation may or may not follow. But this last paragraph is a distraction from our point of disagreement. The debate about whether inflation occurs is a whole other can of worms. Trying to get agreement on the first point.

  18. Spencer

    The economy is being run in reverse. Banks don’t lend deposits. Deposits are the result of lending. Ergo, all bank-held savings are frozen, lost to both consumption and investment. This is the source of secular stagnation, a deceleration in Vt. Bank-held savings have a zero payments velocity. An increase in bank-held savings shrinks gDp.

    This is confirmed by Dr. Philip Georges’ “The Riddle of Money Finally Solved”.

    This was originally posited by Dr. Leland James Pritchard, Ph.D., Economics, Chicago 1933, M.S. Statistics, Syracuse:. “Should Commercial Banks Accept Savings Deposits?” Conference on Savings and Residential Financing 1961 Proceedings, United States Savings and loan league, Chicago, 1961, 42, 43.

    The 1966 Interest Rate Adjustment Act and the “Taper Tantrum” are prima facie evidence (FDIC’s reduction in Deposit insurance, from unlimited to $250,000).

    –Danielle Dimartino Booth’s book: “Fed Up”, pg. 218
    “Before the financial crisis, accounts were insured up to the first $100,000 by the FDIC. That limit kept enormous sums in the shadow banking system. After the crisis, the FDIC raised the insured account limit to $250,000.

  19. Spencer

    re: “so did Japan”

    Japan’s “lost decade” is due to the impoundment and ensconcing of monetary savings in their banks. The BOJ has unlimited transaction deposit insurance, the Japanese save more, and keep more of their savings impounded in their banks.

    “Japanese households have 52% of their money in currency & deposits, and they have unlimited deposit insurance for transaction’s accounts, vs 35% for people in the Eurozone and 14% for the US.”

    Whether the public saves or dis-saves, chooses to hold their savings in the commercial banks or to transfer them to non-banks will not per se, alter the total assets or liabilities of the commercial banks nor alter the forms of these assets and liabilities.

  20. Spencer

    The DFIs could continue to lend/invest even if the non-bank public ceased to save altogether. The size of the commercial banking system is predicated on monetary policy, not on whether the non-bank public saves or dis-saves.

    Just read Sheila Bair’s book: “Bull By the Horn’s”
    The ECB guaranteed a lot more bank-holding company debt than the FDIC. That destroyed money velocity over and above that in the U.S.

  21. rsm

    Why ignore that QE bought trillions in MBS too, in addition to Treasuries, and those MBS were going no bid so holders really had $0 but then the Fed gave them new money?

    How can you turn a blind eye to how the Fed created money to make markets in assets that otherwise would have sunk to $0?

    Are you all so faithful to theory that you handwave away inconvenient facts like that MBS had no bids until the Fed started handing out new money to give them an acceptable price?

  22. W.E.

    Hi, sorry for being off topic but i wanted to ask about bank reserves. How does commercial bank get reserves from the FED, logic dictates that it has to give something to the FED in exchange for reserves but what exactly? It cant be “retail” bank money that commercial bank creates, it cant be treasury bonds either because that would imply that FED does QE and buys assets… so is it physical cash only?

    • rsm

      Cash for trash, via repo and other lesser-publicized facilities?

    • Spencer

      Paul Volcker was quoted in the WSJ in 1983 that the Fed: “as a matter of principle favors payment of interest on all reserve balances” … “on rounds of equity”. [sic]

      This Romulan cloaking device, the payment of interest on IBDDs, vastly exceeded the level of short-term interest rates which is still illegal per the FSRRA of 2006. That’s what caused the repo spike in Sept. 2009 (an interest rate inversion). Remember Reg. Q Ceilings that gave nonbanks a 3/4 point interest rate differential in 1966 (the first “credit crunch”)?

      When you sterilize excess reserve balances, you’re simultaneously increasing the supply of loan funds, LSAPs on sovereigns, while decreasing the demand for Treasuries (taking them off the private funding market). This suppresses interest rates.

      Bank-held savings, frozen savings, destroys the velocity of circulation (idling more funds). Bank-held savings have a zero payment’s velocity. The FDIC raised insurance rates to unlimited for transaction accounts (like the BOJ), sucking funds out of the nonbanks, inducing nonbank disintermediation.

      –Danielle Dimartino Booth’s book: “Fed Up”, pg. 218
      “Before the financial crisis, accounts were insured up to the first $100,000 by the FDIC. That limit kept enormous sums in the shadow banking system. After the crisis, the FDIC raised the insured account limit to $250,000. But trillions of dollars still sate outside the traditional banking system. The “safe” money had no place to go expect money market mutual funds and government securities, leading to a shortage of T-Bills and a corresponding drop in yield.”

      The suppression of interest rates (decline in real rates of interest) boosts relative asset prices. BOE: “QE initially increases the amount of bank deposits (outside money), those bank-holding companies own (in place of the assets they sell). Those companies will then wish to rebalance their portfolios of assets by buying higher-yielding assets, raising the price of those assets and stimulating spending in the economy.”

      (100) Quantitative Easing Is the Biggest Sham Ever (S3 E2) – YouTube

      That’s example is how QE affects the stock market. But that analysis ignores the TGFA and commercial bank credit.

  23. eg

    Raises some interesting questions about the distributional effects, also — thanks for this.

  24. Spencer

    AD, money times velocity, is still too high in the 4th qtr. So, the target for N-gDp in the 4th qtr. is still too high. But that should change in the 1st qtr. of 2023.

    Economists don’t understand money and Central banking. Milton Friedman, for instance, explains that “Fisher, in his original version, used T to refer to all transactions – purchases of final goods and services…, intermediate transactions…, and capital transactions (the purchase of a house or a share of stock).

    In current usage, the item has come to be interpreted as referring to purchases of final goods and services only, and the notation has been changed accordingly, T being replaced by y, as corresponding to real income” (Friedman, 1990, p. 38).

    Monetarism involves controlling total legal reserves, not excess reserve balances, not just nonborrowed reserves either. A decrease in required reserve balances (which Powell eliminated), has an immediate dampening impact on AD, on the economy, on N-gDp.

    From Carol A. Ledenham’s Hoover Institution archives: Friedman pontificated that:
    : “I would make reserve requirements the same for time and demand deposits”. Dec. 16, 1959.

    Under monetarism, the monetary authorities use two tools to control the money supply — legal reserves and reserve ratios. If these tools are to be effective, all legal reserves of all money creating institutions have to be in a form which the monetary authorities can quickly ascertain and absolutely control. The only type of bank asset that fulfills this requirement is interbank demand deposits in the District Reserve banks owned by the member banks (like the ECB).

    Similarly, the monetary authorities have to have complete discretion over changes in reserve ratios. This is essential since under fractional reserve banking (the essence of commercial banking) these ratios determine the minimum volume of legal reserves a bank must hold against a specific volume and type of deposit liability.

  25. J. Thomas

    Thanks for hosting an interesting site with unique content.

    It seems to me that today’s so called ‘monetary policies’ are about 50 years behind the reality of the functional pseudo-free economy. All of these olds dogs only know the same limited tricks. If all you have is a hammer, every problem looks like a nail … And, they are historically late to the party and bring too large a hammer. There are far too many regulations, tariffs, derivatives, hedges, and complex financial so called ‘instruments’ to think you can correct it all with a common rate.

    Base interest rates should be connected to money supply. As long as we have a political class hell-bent on spending their way into the history books, the FED will always be chasing their tail. Congress should pass legislation to tie the funds rate to M2. If they want to print fait more, they know the’ll have to take the associated rate hike. Consequently, if they want to reduce the funds rate, they’ll need to get the money off the streets with taxation or spending cuts. You know, like fiscally intelligent people.

    There are two separate steering wheels on the same car and Congress and the FED don’t see the road the same way … we all know how it’s going to end. Legislate the funds rate to M2 and stop screwing with our energy supplies. We can get rid of the entire FED once and for all.

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