Is the Size of the Fed's Balance Sheet More Important than the Target Rate?
In a recent interview on CNBC's Squawk Box, Neel Kashkari explained his dissenting position on the March rate hike. His position was that there is not yet enough inflation. In fact, he thinks that the Fed's 2% inflation target shouldn't be seen as a hard ceiling. He even stated that predictions of coming inflation worries are baseless:
For the last five or six years, the Federal Reserve keeps predicting inflation is around the corner. And those predictions end up being wrong.
Of course, with the massive expansion of the Fed's balance sheet going into areas like the stock, bond, and housing markets, the Fed's measures of inflation don't even reveal what is happening to the economy's capital structure. Distortions in the capital markets are far more serious than than the PCE represents. It's frustrating enough that the central bankers are trying to increase the cost of living. But then we are reminded that they don't even know how credit expansion impacts the boom and bust cycle.
What is interesting though, is Kashkari's opinion that addressing the gigantic balance sheet should come prior to any further rate hikes:
As we move forward, we allow the balance sheet to start running off. Then we can return to fed funds rate hikes when the data call for it. The balance sheet should be the next move.
This preference of balance sheet before rate hikes is also unique among the FOMC members — everyone else wants the balance sheet scaled back to follow additional rate hikes. It will be interesting to see whether Kashkari's opinion on this gains any ground among the other members. Perhaps we will get a further indication as we approach the May and June Fed meetings.