The Federal Reserve’s ‘Interest On Reserves’ Doesn’t Contain Inflation

The difference between what economists believe and what’s true is Pacific Ocean vast. Think the popular view that the Federal Reserve, by paying banks to park reserves at the central bank, is containing inflation. Where to begin?

First, inflation is one thing and one thing only: a shrinkage of the exchange medium circulating such that it exchanges for fewer and fewer market goods. In our case, inflation is a shrinkage of the dollar. Except that the dollar’s exchange value isn’t, nor has it ever been, part of the Fed’s policy portfolio.

What about interest on reserves? What about it? If we ignore that lending has nothing to do with inflation to begin with, what wasted thought.

That’s because credit is produced, not decreed or managed by central banks. Individuals, banks, and governments borrow money not to stare lovingly at it, but for what it can be exchanged for. Which is just a comment that credit is an effect of production, nothing else.

Economists ascribe an inflationary quality to borrowing which implies impressive market stupidity. Really, what individual, business or government would take on debt just to take it on? Tick tock, tick tock.

The answer to the above is what is once again true: credit is produced, which means lending grows alongside production. Looking ahead, and in consideration of the extraordinary production surge that awaits as AI and other labor-saving advances render humans superhuman in terms of their ability to generate endless plenty, credit availability today will be but a tiny fraction of what it is in the future.

Stop and think about what this means. As credit availability surges, the effect will be a “cheap revolution” (Rich Karlgaard of Forbes long ago created, popularized the term, or both) that’s going to make today appear austere by comparison. Translated, the surest sign of economic growth is falling prices, not rising.

Which is important to remember when considering the once again popular (and baseless) view of economists that the Fed is containing prices by paying banks for the right to theoretically sideline the monies entrusted to them. Implied in such a view is the opposite of what’s true, that lending is inflationary because lending associates with economic growth that allegedly pushes up prices as prospering individuals buy, and buy, and buy. Let’s refer to the latter as fallacy on top of fallacy on top of fallacy.

Demand is an effect of production, nothing else. Translated, the more people are producing the more they’re demanding. To imagine that demand can outpace supply is to misunderstand how people demand in the first place.

Second, what we don’t spend as our production grows exists as capital for innovators to be matched with, on the way to even more production of myriad goods and services at prices that continue to decline. At present, hundreds of billions are finding their way to AI and other labor-saving advances that will yet again push down the cost of everything while simultaneously leading buyers to all new wants and needs they never knew they had.

Despite this, fallacy-stalked economists just dying to be distracted are focused on the Fed paying interest to banks so that they’ll lend less? Forget that the latter has nothing to do with inflation, forget that banks are but a shrinking portion of soaring amounts of global credit, and just remember that a bank lending to the Fed doesn’t nor will it have any impact on the growth aspects of the U.S. economy, growth that by its very name will associate with rapidly declining prices.

Economists are most effective at being irrelevant. Their focus on interest on reserves helps explain why.