FED Monetary Policy and Inflation

One of the major (if not THE major) causes of inflation are FED actions (the other is Congress’s spending). Both factors affect the money supply, and an increased money supply typically results in either price inflation or asset inflation (i.e., rising stocks, housing, gold, etc). Excess liquidity also tends to boost employment in addition to prices.

When money is abundant:

• Banks have more reserves, which they want to put to work, so interest rates fall and credit becomes easier to obtain.

Businesses borrow more cheaply, which encourages:

• Expanding operations, i.e., opening new locations, investing in equipment, and hiring additional workers

Monetary Policy vs. Fiscal Policy

Monetary Policy

Controlled by: The central bank (in the U.S., the Federal Reserve System)

Main goal: Control inflation, stabilize prices, and support employment

• Controls the money supply and interest rates.
• Targets price stability, maximum employment, and stable economic growth.
• Tools include:

• Adjusting short‑term interest rates
• Open market operations
• Reserve requirements
• Forward guidance

Fiscal Policy

Controlled by: The federal government (Congress and the President in the U.S.)

Main goal: Influence economic growth, employment, and income distribution.

• Uses government spending and taxation to influence economic activity.
• Can stimulate or slow the economy through:
  • Infrastructure spending
  • Tax cuts or increases
  • Transfer payments (e.g., unemployment benefits, or stimulus checks)
• Designed to affect GDP, employment, and inflation through direct spending decisions.

Funding the government falls under fiscal policy.

More specifically, it’s part of the government’s budget process, which includes:

1. Revenue (how money comes in)

   • Income taxes

   • Corporate taxes

   • Payroll taxes

   • Tariffs and other fees

2. Borrowing (when revenue isn’t enough)

a. Issuing Treasury securities:

• • Treasury bills
  • Treasury notes
  • Treasury bonds

b. Increasing or suspending the debt ceiling

The central bank (e.g., the Federal Reserve) may buy or sell Treasuries as part of monetary policy, but the decision to borrow in the first place is fiscal.

Funding the government isn’t just about raising money — it’s also about allocating it:

• Defense spending
• Social Security
• Medicare/Medicaid
• Infrastructure
• Education
• Research
• Transfers and subsidies

All of this is fiscal policy.

Funding the government — through taxes, fees, and borrowing — is entirely a fiscal policy function. Monetary policy only interacts with government funding indirectly when the central bank buys or sells government debt to influence interest rates and liquidity.

The FED’s Mandate

The Federal Reserve Act of 1977 modified the original act that established the Federal Reserve in 1913 and redefined its role to not only manage fiscal policy but also to try to maintain “maximum employment”. This was termed their “Dual Mandate”, so in addition to stable prices and moderate long-term interest rates, the FED was charged with trying to create jobs (through monetary policy). This change was necessary to clarify that low inflation was not the only goal, if it was at the expense of job creation.

After a decade of low inflation, the FED changed its policy goals again in 2020, to not just balance jobs and inflation but to actually prioritize Job creation over low inflation.

Federal Funds Rate:

The chart below shows the effective federal funds rate since 2015. Notice how quickly interest rates climbed beginning in February 2022, rising from just 0.08% to 4.57% one year later. The rate then peaked and remained at 5.33% for several months before the Federal Reserve began easing monetary policy in September 2024.

The effective federal funds rate declined to 4.83% in October 2024. In November, the Fed lowered its target range by 25 basis points to 4.50%–4.75%, and the effective rate averaged 4.48% in December. At its December 2024 meeting, the Fed reduced the target range again to 4.25%–4.50%.

On September 17, 2025, the Federal Reserve lowered its target range for the federal funds rate by 25 basis points to 4.00%–4.25%, its first rate cut in nine months. It followed with another 25-basis-point cut on October 29, 2025, reducing the target range to 3.75%–4.00%. Then, on December 10, 2025, the Fed approved a third consecutive 25-basis-point reduction, bringing the target range to 3.50%–3.75%. The effective federal funds rate averaged 3.72% in December, near the upper end of the target range. At its April 2026 meeting, the Federal Reserve left the target range unchanged.

Taking a longer-term view  (below) gives a better picture. The common consensus seems to be that current rates are extremely high, but in this view, we can see that we are below the average rate since 1954, which is 4.6%.

Fed Funds Rate

Note: In the chart below, you can zoom in on a certain range by dragging across it.

Data Source: Board of Governors of the Federal Reserve System (US)

Quantitative Policy

The Fed officially ended its quantitative tightening (QT) program effective December 1, 2025, stopping the automatic runoff of its large portfolio of Treasury and agency securities that had been shrinking the balance sheet since 2022. But… Despite the FED cutting rates twice in 2025 …

Lowering rates usually reduces the demand for reserves, which should ease liquidity pressure.

But the opposite happened:

• Years of quantitative tightening (QT) had pushed bank reserves toward the lower boundary of “ample reserves.”
• As rates dropped, demand for repos and T-bills increased.
• Money market conditions tightened further.

Result:
Even though the Fed cut rates, short-term funding markets got tighter because QT had shrunk reserves too much.

So, on December 10, 2025, the Fed announced “Reserve Management Purchases” (RMPs):

• Roughly $40B in T-bill purchases in the first month
• All principal payments reinvested into T-bills
• Authorization for more short-maturity purchases as needed

This effectively re-expands the balance sheet, although in a controlled, short-term-focused manner.

Why not call it QE?

Because:

• They are buying only short-term Treasury bills
• The purpose is technical liquidity management, not stimulating the economy
• They are not trying to push down long-term interest rates or support asset markets

This is QE-lite, not classic QE.

Although the FED is not currently targeting Long Term Bond rates the Treasury is Buying them in an effort to:

• Provide liquidity support in long‑dated sectors where yields have surged.
• Absorb older, less liquid long‑term securities to improve market functioning.
• Attempt to calm volatility after 30‑year yields hit 19‑year highs (5.34%)

In other words, demand wasn’t strong enough so rates on long-term (30 years) bonds were creeping up to levels the government didn’t like so they are trying to decrease supply so rates will go lower. But even after buybacks, yields have remained elevated:

• 10‑year: ~4.84%
• 20‑year: ~5.31%
• 30‑year: ~5.30%

M2 Money Supply

Looking at the M2 money supply, we see a steady growth of the money supply from 1995 through 2008, then a steeper increase through 2020, followed by a sharp spike during COVID. And then a slightly less sharp incline for the next couple of years, taking M2 to 22 trillion dollars in 2022. From 2022 to 2023, we finally see a brief decline in M2 as the FED followed a tighter monetary policy before M2 began expanding.

Rather than continuing to decline in 2023 through 2025 as FED assets do, M2 returns to roughly the same slope of increase as from 2012-2020, despite FED assets declining. This could be the reason for the rebound in the stock market, beginning at about the same time as this uptick in M2. The more money sloshing around in the system, the more that finds its way into the stock market.

Money Supply (M2) vs QP ( i.e., QE & QT)

What is M2-

M2 is a monetary aggregate—a statistical measure that tracks the total supply of money in an economy. It includes physical currency, checking accounts (M1), plus “near money” like savings accounts, money market funds, and short-term deposits that can be quickly converted to cash. M2 serves as an important indicator of money supply and liquidity in the financial system, and central banks monitor it to gauge inflation risks and economic activity.

• When the U.S. Treasury spends money it doesn’t have (deficit spending), aka, printing money, that money flows into the private sector, including government contractors, welfare recipients, and federal employees, Social Security beneficiaries, infrastructure projects, healthcare providers through Medicare and Medicaid, defense suppliers, and bondholders who receive interest payments on government debt. Thus, increasing the M2 money supply.
• Between 2023–2025, the federal government ran very large deficits (roughly $1.7–$2.0T+ per year).

What is Quantitative Policy (QP)-

Quantitative Easing (or QE) is an unconventional monetary policy tool (developed during the 2008 crash, by the FED to stimulate the economy when traditional methods like lowering interest rates have become ineffective—typically because rates are already near zero.

In QE, the central bank creates new money electronically and uses it to purchase large quantities of financial assets, primarily long-term government bonds and sometimes mortgage-backed securities or corporate bonds, directly from banks and financial institutions. This process:

1. Injects liquidity into the financial system by expanding bank reserves
2. Lowers long-term interest rates by driving up demand (and thus prices) for bonds
3. Encourages lending and investment by making it cheaper to borrow and pushing investors toward riskier, higher-yielding assets
4. Expands the central bank’s balance sheet significantly, sometimes by trillions of dollars
5. Restores confidence in the markets by providing a “backstop” and buying up the junk (like mortgage backed securities) that the market wants to dump.

Quantitative Tightening (QT) removes reserves held by banks at the Fed, not deposits held by the public.

• QT shrinks the Fed’s balance sheet and reduces liquidity.

When the Federal Reserve implements QT, it stops reinvesting proceeds from maturing bonds and may actively sell securities from its balance sheet. This removes reserves from the banking system—essentially pulling money out of circulation. As bank reserves decline, banks have less capacity to create loans (since lending creates new deposits, which are part of M2). Additionally, as the Fed sells bonds, it drives bond prices down and yields up, making bonds more attractive relative to the money market funds and savings accounts that comprise part of M2. This can cause money to flow out of M2 components and into assets that aren’t counted in M2.

While QT mechanically reduces the monetary base and constrains bank lending capacity (which should shrink M2), the actual impact on M2 depends on how banks, businesses, and consumers respond to the changing liquidity conditions. In essence, QT tightens the money supply “plumbing,” and M2 usually contracts as a result—but the magnitude and timing vary based on broader economic conditions and behavioral responses.

Source: FRED M2 Money Supply

Global M2

The FED is not entirely responsible for the Global M2 Money Supply; it is the composite of the major countries’ money supplies. But where the FED leads the other countries tend to follow. Generally, an increase in the money supply will result in a rising stock market with a 2 to 4-month delay. In the chart, we can see the massive increase in Global M2 during COVID, and the relatively small decrease in money supply for the following Quantitative Tightening. Then we see successively higher peaks. There was another large increase in the money supply in the first half of 2025 and then a slightly smaller rate of increase in the second half of 2025. But it looks like another increase began in 2026 before flattening out. Perhaps the money supply is beginning to increase again.

The above chart was created with TradingView. Using its charting tools, real-time market data, and programmability, you can create your own charts as well. Go HERE to create your own FREE account.

Historical FED Actions

In April 2020, the FED began fighting Deflation with a massive Quantitative Easing program and near-zero Fed Funds rates, and by June, the FED showed signs of slacking off. However, it continued to increase assets and keep interest rates very low until February 2022. With inflation at over 7% (i.e., well over the FED target of 2%), they finally decided to curtail their massive stimulus.

In April 2020, we published this FED Assets chart and said that FED assets could easily reach 9 Trillion…

And two years later, that is precisely what happened. FED assets peaked at 8.965 trillion on April 13^th, 2022. By December 7^th, FED assets had decreased to 8.582 trillion, and on March 1^st, they bottomed at 8.39 trillion, for roughly a 2/3 trillion decrease.

But then a banking crisis broke out in California, and the FED jumped Funds back up, wiping out roughly 38% of the gains they made. Since then, the FED has been decreasing assets again. In July 2023, it broke below the March 2023 low, hitting 8.298 trillion.

As of August 6, 2025, FED assets were down to 6,640,843 million (6.64 Trillion) from 6,672,885 million (6.67 Trillion) in June or basically, back to April 2020 levels. By September 3rd FED assets were 6,602,071 million (6.602 Trillion).

Quantitative Tightening 2.0

The Fed’s first QT ended in August 2019. The second round of QT (QT2) began in June 2022, when the Fed allowed its balance sheet to begin shrinking.  The FED ended QT2 in December 2025 with FED “Assets” around 6.5 trillion. Since then, assets have increased to 6.71 trillion.

QT 2 has ended, and QE Lite has started.

FED Assets

History of Quantitative Easing

The market crash of 2008 destroyed liquidity and created massive deflationary forces, so the FED began fighting against deflation through traditional means and then through newly created Quantitative Easing. Then in November 2015, the FED switched sides and began slowly raising interest rates to fight against Inflation. From there, inflation rose from July 2016 through February 2017, convincing the FED that it was safe to raise rates more aggressively.   On March 15, 2017, the Fed voted to raise its benchmark FED-funds rate by a quarter percentage point to a range of 0.75% to 1% on the assumption that inflation was building (and because they were desperate to raise rates so they would have somewhere to go in the next recession). At its June 2017 meeting, they decided to increase it by another quarter percentage point bringing the benchmark rate to a (1.0% to 1.25%) range. Those were their target ranges.

Throughout 2018 the FED followed a policy of  Quantitative Tightening (QT) and raised the FED Funds rate that they charge banks.  QT is the opposite of Quantitative Easing. In “Quantitative Easing” (QE), the FED acquires government debt by buying it on the open market. QT is a process whereby the FED reduces the debt held by not renewing Federal Debt when it matures.

According to the National Bureau of Economic Research (NBER), the U.S. entered a recession in February 2020 (shaded area) after the longest boom in economic history. According to NBER, the peak occurred in February 2020. Since unemployment was COVID-related rather than just a typical slowing economy, economic activity rose again rather quickly. In July 2021, NBER declared the bottom had occurred only a couple of months after the recession began. Thus giving us the shortest recession on record. But then we began feeling the consequences of all that money pumping.

See NYSE ROC for more info on how this may affect the stock market.

Quantitative Easing (and Inflation)

On November 25, 2008, the Federal Reserve announced that it would take the unprecedented step of purchasing up to $600 billion in agency mortgage-backed securities (MBS) and agency debt. This was the beginning of the Quantitative Easing program and later called QE1.

In December, the FED cut interest rates to near Zero.

In March 2009, the FED announced that it would purchase another $750 Billion in junk mortgages (Mortgage Backed Securities) and $300 Billion in Treasury Securities primarily because inflation was still heading down.

There is often a lag in the effects of money creation, but as QE1 ended, the inflation rate again began dropping, spending much of 2010 at just over 1%.

So the FED decides QE2 is necessary, and this time, it purchases another $600 Billion of Longer-Term Treasury Notes. The inflation rate increases to almost 4%, but when QE2 stops, the inflation rate begins falling again. Personally, I would love to see the inflation rate stay between 1 and 2% or, better yet, between 0% and 1%. In the long run, steady low inflation rates benefit everyone as people can accurately judge their future costs and make sound business decisions. But the government prefers a higher inflation rate so it can repay its massive debts with “cheaper dollars.” Inflation also erodes savings and causes consumers to act imprudently and spend more than they would if they had sound (unchanging) money. This is what the government means by “stimulating the economy”, i.e., causing people to spend more than they would prudently do otherwise. The apparent long-term effects are a society with more debt than it should have, and thus we see crashes as we saw in 2008. Then the government has to “do something,” so it prints more money to fix the problem it created by printing money in the first place. For more detail, see: Stimulate the Economy? Please Don’t!

On September 21, 2011, the Federal Open Market Committee announced Operation Twist which was designed to affect interest rates by the simultaneous buying of long-term bonds and selling short-term bonds.

On September 13, 2012, the FED announced QE3, which was $40 Billion a month in purchases, and on December 12, 2012, they announced an additional $45 Billion per month with no definite end in sight.

We’ve added QE1, through QE5, QT 1&2 to the chart so that you can see the effects on the inflation rate. These “Quantitative Easing” schemes were not your typical FED money-printing schemes. In QE1, which lasted from November 25th, 2008 to March 31, 2010, the FED started by purchasing $500 Billion in Mortgage-backed securities. Most of these securities were virtually worthless at this point (but they paid full price). But a few months earlier, they were considered part of the larger money supply. So in effect, the FED bailed out the owners of this junk debt and pumped up the money supply simultaneously by converting worthless junk into “valuable” greenbacks.

In December, Ben Bernanke began “tapering,” which slowly shut off the flow of easy money, and by October 2014, the flow was stopped entirely.

In the video, What is the Real Purpose of the Federal Reserve? Edward Griffen reminds us that the Federal Reserve is just a bank cartel, and it primarily has its members’ interests at heart. So, monetizing worthless junk paper and bailing out the banks that held them makes perfect sense when viewed in that light.

About Tim McMahon

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