Wavering Monetary Policy: Markets Can’t Be Fooled with Stopgap Measures

Stagflation, where inflation and recession occur at the same time, is appearing around the world. In the United States, facing the highest inflation in 30 years, the Federal Reserve has raised interest rates sharply. Korea’s monetary authorities are also raising rates one after another. This is, of course, the conventional response. But on closer inspection, it amounts to the very party that caused inflation stepping forward to solve the problem again. To find the right solution, we must clearly understand the essence of the problem and why this confusion arose.

What led the COVID period into inflation and recession was the failure of U.S. monetary policy. It was the result of maintaining excessive monetary expansion for a prolonged period. The more money was released, the greater the inflationary pressure became. The fact that most countries followed suit by expanding the money supply and increasing fiscal spending also worsened the problem. In other words, what should have been resolved in the short term was turned into a long-term crisis.

When money is supplied without limit over a long period, serious side effects are unavoidable. Because money becomes abundant, people fall into illusion. They mistake it for genuine demand or misjudge the situation as one requiring new investment. As a result, businesses may overinvest, and even when demand is weak, a boom can arise in the market. It can also lead to overheating in the stock market or rising real estate prices.

The larger the boom created by the government’s expansion of the money supply, the greater the side effects that follow when the bubble bursts. The process of withdrawing money again is painful. Bad investments are revealed as failures, and as the boom collapses, investor losses increase, causing recession and unemployment. The downturn grows deeper and lasts longer. A wavering monetary policy that first floods the market with money and then abruptly tightens it again is, in itself, evidence of failure. The more policy failure is repeated, the greater the shocks and side effects the economy must endure.

The practice of releasing money through quantitative easing has been repeated since the 2000s. In addition to sharply lowering interest rates and maintaining a near-zero rate environment for a long period, thereby distorting the market, monetary authorities have also increased the money supply through quantitative easing. The expansion of the money supply that began during the 2009 global financial crisis grew sharply again during COVID, ultimately producing the current inflation crisis.

The basic solution to inflation is to withdraw the excess money that has been released. In truth, there is no real alternative. To reduce the money supply, rising interest rates are unavoidable. But the monetary authorities making a great show of fighting inflation are the very main culprits behind it. When recession occurs, it is common for governments to step forward and release more money. But monetary authorities cannot overcome a crisis by deceiving people through monetary expansion. Temporarily numbing the pain does not eliminate the essence of the problem; rather, it only brings greater long-term side effects.

What is even clearer is that governments have always encouraged inflation. For one reason or another, they have arbitrarily increased the money supply and collected an invisible tax through inflation.

A country with sound money is an advanced country, one that enjoys economic prosperity and stability. Arbitrary government monetary policy and interest rate policy bring the aftereffects of inflation and prolong crises. To preserve monetary soundness, money must be freed from the government’s grip.

Some may respond in extreme terms by asking whether that means doing nothing at all and simply standing by. From a political standpoint, the government may want to create the impression that it is responding well by releasing money and making it seem as though the crisis has quickly disappeared. But the market is honest, and the outcome cannot be deceived. The long-term aftereffects are greater than the temporary calming effect.

Money printing and interest rate policies undertaken in the name of reviving the economy create harmful aftereffects. We must move beyond the belief that government can solve everything and establish a proper framework for the operation of interest rate policy.

Sung-no Choi, President of the Center for Free Enterprise (CFE)

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Original title: 갈팡질팡하는 통화정책, 미봉책으로 市場 속일 수 없다

Author: Sung-no Choi

Date: 2022-10-05

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=24993