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How the budget deficits caused US inflation

By Michael Knox - posted Wednesday, 11 May 2022

How the Fed Policy works

The mechanism of how Fed policy works in the US is different to how it happens in Australia. What happens is as the Fed funds rate goes up that number goes into private trading algorithms for mortgages. As the Fed funds rate goes up, this generates a higher equilibrium yield for mortgages. Long-term mortgage securities sell-off and mortgage interest rates go up. This is what drives a slowdown in the US economy. When you want to understand the US economy, do not look at the Fed funds rate; look at the mortgage yield.

I think that what the Fed is doing is vastly more powerful than commentators understand, it is a lot more than just putting up short rates. What the Fed is doing with its balance sheet is important, and what the Fed is doing is much more powerful than commentators believe.

Action in the Fed balance sheet is going to really bite, and you will see it really biting in mortgage interest rates. That is going to have an immensely powerful effect in slowing the US economy and reducing US inflation both next year and the year after.



Budget deficits, not the Fed, caused US inflation. Still, the Fed has powerful tools to control the damage that deficits have done.


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About the Author

Michael Knox is Chief Economist and Director of Strategy at Morgans.

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All articles by Michael Knox

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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