The Fed’s Monetary Policy and Inflation: Debunking the Myth of Physically Destroying Money

There is a common misconception among individuals who have bought into certain arguments that seem metaphorical, but when taken literally, lead them in the wrong direction. One of these is the idea that destroying money can counteract inflation. While the Federal Reserve (the Fed) does play a crucial role in monetary policy, simply physically destroying money is neither feasible nor effective in addressing inflation issues.

The Reality of the Fed’s Role in Money Supply

The misconception arises from a misunderstanding of the Fed's actual role in the money supply. Contrary to the belief that the Fed prints money, it primarily controls the currency in circulation and the monetary base. However, the total money supply in an economy is far more extensive and includes checking accounts, savings accounts, certificates of deposit (CDs), and other money-like instruments.

The Fed does not have direct control over the entire money supply. Instead, it influences it through various monetary policy measures. The Fed’s monetary base is only one component of the broader money supply, and its actions aim to influence overall economic conditions rather than directly controlling the total amount of money in circulation.

Addressing Inflation: A Broader Economic Issue

Inflation is a complex economic phenomenon, rooted in a variety of factors. One of the primary causes of current inflation is the rapid shift in wealth towards more easily spendable assets, such as cash, while other assets like real estate, stocks, and even clothing become less accessible to spending. This shift is largely influenced by the unprecedented expansion of the monetary base over the last 15 years.

The Fed’s expansionary monetary policy has made it easier for individuals and institutions to create more money as needed, leading to a higher nominal value of the money supply. This is particularly evident in periods of economic uncertainty, such as the aftermath of the pandemic and subsequent lockdowns, where production and supply chains have not fully recovered, contributing to a mismatch between the available money and the goods and services needed.

Adjusting for Inflation: A Gradual Process

Addressing inflation is not a matter of physically destroying money. Instead, it involves a gradual process of rebalancing wealth and economic conditions. Inflation will ease when individuals shift their wealth back towards forms that are less easy to spend, such as investments in real estate, stocks, and durable goods.

Policymakers are continuously assessing the economy to find the right balance. While it is challenging to pinpoint the exact amount by which the money supply is over what it should be, estimates range from 10% to 50%. This wide range reflects the complexity of the issue and the various factors influencing the economy.

Conclusion

The Fed’s role in monetary policy is critical, but attempting to reverse inflation by physically destroying money is impractical and ineffective. The true solution lies in understanding the broader economic forces at play and allowing the market to adjust over time. By supporting sound monetary policies and fostering an environment where economic activity can normalize, we can better manage and mitigate inflationary pressures.

Keyword: inflation, monetary policy, Fed