Congressman: Federal Reserve Policy Could Lead to Huge Inflation, Recession

Jeb Hensarling says Fed does not have the credibility and respect it once had

Janet Yellen
Janet Yellen / AP
June 9, 2016

Rep. Jeb Hensarling (R., Texas) said in a Wednesday interview with the Washington Free Beacon that when the Federal Reserve begins to unwind its balance sheet of roughly $4.5 trillion there will be a bout of inflation or possibly a recession.

The Fed traditionally conducts monetary policy by setting the federal funds rate, "the rate at which banks borrow and lend reserves on an overnight basis." The Fed lowered this rate almost to zero in December 2008 after the economy sunk into recession due to the financial crisis. After some time, the Fed injected more money into the economy by purchasing Treasury and mortgage-backed securities. Between 2009 and 2014, the Federal Reserve made large-scale asset purchases, known as quantitative easing, which increased the size of the Fed’s balance sheet to $4.5 trillion in October 2014.

"The more probable scenario is we are at some point going to be in a bout of huge inflation or we’re going to be back in a bad recession," Hensarling said. "They have a huge balance sheet that they have to unwind and depending on if you unwind it too quickly, if you unwind it too slowly, you could either end up with high inflationary pressures or you could throw the economy back into a recession."

"It’s problematic and it’s dangerous what they’re doing," Hensarling said. "We need monetary policy to be predictable, rules based, and easily communicated to the public so everybody can plan their financial affairs around knowing what the value of money will be. Today we don’t know."

The Fed finally raised interest rates to a quarter of a percentage point in December 2015 after keeping them near zero since 2008. Hensarling said that he is not trying to get interest rates to either increase or decrease but he is advocating for a more predictable, rules-based monetary policy.

"What I decry is this kind of Wizard of Oz going behind the curtain and playing around with all of these levers and no one ever knowing what’s going to happen from day to day, week to week, what’s going to happen to the value of money which helps put capital on the sideline," Hensarling said.

"I fear that there are asset bubbles that are being created throughout our economy because of what they do," he said. "For example, in the mortgage backed securities area and other areas they have chosen to intervene, so I think we need a more market-based interest rate than what we’re getting today."

"No doubt the Fed has chosen to keep interest rates artificially low for an extended period of time. It clearly has not had the desired effect," he said.

Hensarling has introduced legislation called the Financial CHOICE Act, which stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs, which would repeal and replace Dodd-Frank, a law that regulates the financial industry passed after the financial crisis. Hensarling’s legislation includes measures to ensure that the Fed sticks to a monetary policy that is rules based.

"My main concern is that the Fed come up with a set of metrics," the congressman said. "Here’s how we’re going to conduct monetary policy, here is our approach, here are our variables, here’s our reaction function. If this changes this is what we’re going to do: allow the American people to know what will be the value of their money under what conditions."

The Fed maintains that it should not be audited because it wants to keep Congress, a political body, out of monetary policy, but Hensarling said some of its actions have compromised the Fed’s credibility. Fed Governor Lael Brainard has donated to the Hillary Clinton, for instance.

"Every Fed governor has been appointed by Barack Obama and regrettably they have lost a lot of credibility and it’s increasingly just morphed into one more entity of the Obama administration," Hensarling said. "The Fed does not have the credibility and respect they once had."

Hensarling said that monetary policy cannot fix the economy completely and that there should be more focus on fiscal policy.

"We need fundamental tax reform, we need to repeal Dodd-Frank, and we need to return to the rule of law and this economy would boom for working Americans and would help lift people out of poverty," he said. "That’s what we need and a perpetual zero interest rate policy is only going to do more harm than good."