I Stumped Tom Woods!

I went to an excellent lecture last night by Tom Woods in Phoenix. I’ve read one of Tom’s books (Meltdown) and am almost done with my second (Nullification). He’s one of my favorite Austrian Economist speakers and authors. He’s very entertaining, insightful, and knowledgeable.

After the lecture, he was doing a book signing and I was able to meet him and snap a photo:

Meeting him in person, I have to say, he is one of the most enjoyable people I have ever been around.

Now, the title of this post is sort of a joke and a play on my other post, “I met Ron Paul!” I was able to speak with Tom for a moment and wanted to ask him a question that I haven’t been able to figure out, and I stumped him! For those interested, I asked him: “One of the ways the Federal Reserve artificially lowers interest rates is by printing money and pumping it into the system. How do they keep them low, as they are doing right now, without continually pumping more money into the system?” He didn’t know the answer and I felt real smart :) BUT, he did refer me to Bob Murphy and told me to forward the answer back to him.

Bob Murphy is actually one of my other favorite Austrian Economic lecturers and is also very knowledgeable and entertaining. I’m sure he’ll know the answer and I’ll post his response here if/when he gets back to me.

UPDATE: Bob Murphy got back to me immediately. Here is his response:

Hey Jeremy,

I guess I would challenge your premise. They have been steadily increasing the monetary base the whole time: [link]

Yes there are some pullbacks, but e.g. people are now speculating that the Fed will buy anywhere from $300billion – $1.5 trillion more in assets starting Nov. 3. It’s called “QE2.”

Part of it is expectations, too. If everybody believes the Fed will intervene to buy up bonds if their price starts slipping (i.e. yield starts rising), then nobody would be so stupid as to sell bonds for less than the target price implies.

Bob,

Thanks for the prompt reply. I think I understand better now. Can you clarify one last bit? The chart you referenced is the same one Joe Salerno did in his recent lecture, which is the chart that made me come up with this question in the first place. Doesn’t the chart show that they have been pulling back and not increasing at all for most of 2010?

Let me answer myself and you correct me if I’m wrong. So the Fed basically pumps up the money supply when it wants to lower rates, and if they have a target of 1%, they know just how much to pump in in order to reach that target. Once they’ve pumped the money in and the target rate is reached, they basically do nothing to keep it there, they only will make monetary adjustments IF other factors, like expectations and such start to move the rate away from the target. Is that correct?

And by extension, if the Fed wants to start raising interest rates, they will have to start pulling back the monetary supply by selling assets from their balance sheet, no?