Should the fed pick winners and losers? They can't not.
The Fisher Equation Rate Hike Puzzle
Raising interest rates is a matter of using nominal rate increases, to increase the cpi adjusted ex post rate by even more, thus reducing inflation.
The fact that a nominal rate increase is relied on to increase real rates by even more, seems to indicate that it would be possible to increase real rates without messing with the nominal rate setting. This is exactly my thesis.
So in this viewpoint, the nominal rate increase either becomes merely Pavlovian, a way of training markets with a signal, and a user interface decision. When we increase real rates by 5%, we should also increase the nominal rate by at least 3 to 4%, so people aren't excessively confused and make poor financial decisions.
After all, bond traders are supposed to be the sophisticated financial parties, able to price in potential duration shocks and other complicated fx dynamics, whereas consumers seeking home and auto loans need the guidance of a nominal rate.
By all accounts, a nominal rate increase without financial defaults, would only lead to an increase in the money supply. If you raise interest rates to a 100% daily rate, for example, without any defaults, everyone's money doubles every day.
So without defaults, a rate increase is a stock split, which is exactly what the fisher equation tells us. So what determines who defaults and who doesn't?
Ostensibly the market is supposed to determine that. A common analogy is that of musical chairs. The fed removes chairs(by paying out interest on reserves, apparently), and then someone is left without one. Why we have to add chairs to remove them is beyond me: people promising more chairs in the future, to secure that one chair they really need today.
So there is a bifurcation or split, between future promised chairs, and the present chairs that are actually available, when you have a rate hike. One way or another, this must be resolved. In this context the nominal rate increase is mostly to preserve the appearance of neutrality. Instead of the fed walking up to you and saying you can't have that chair, they tell you it will cost you two chairs tomorrow.
I have talked before about how rate hikes, even under a commodity unit of account, were always a game of financial brinksmanship. In the most degenerate case, offering a higher or excessive rate with a commodity unit of account is merely a ponzi scheme: you offer impossible returns, hoping to gain a temporary advantage and weasel your way out of consequences.
In reality, the ponzi scheme is unnecessary, when the game is "winner take all". It is not that your promised returns are unsustainable for you, it is that they are for everyone else. This has a surprising amount of overlap for what is popularized as "dollar milk shake" theory, by Brent Johnson.
Without a commodity unit of account, the returns offered cannot be compared directly across currencies, but can still be guessed at, but more specifically, currency issuers cannot be forced into default, the currency is a share of the valuation of respective national debts, or a tax credit, not an on demand claim to a commodity. (the currency is still backed by commodities, but only at tax time, not on demand).
So in a commodity standard, if you offer 5% yield, and everyone else can only manage a 4% yield, than you are able to achieve that, by taking advantage of the distressed firesale of all the losers.
A similar effect is possible with fiat currencies, but it is not automatic. It requires a belief or trust that the offer a higher real yield can be maintained, and real yields are costly.
The simple remedy would be to simply wait to do a modest hike, once the valuation of the national debt falls to a much more modest defensible value. Then you aren't constantly chasing a higher debt valuation with a nominal yield. Anywhoo...
The first round of winners and losers are in the FX and purchasing power parity arena. If people stack dollars, then they export output to the U.S. We enjoy higher living standards, and they get squeezed. That is just the first round though.
In the next round, when there is a domestic financial reckoning, some must win, and some must lose. The central bank can either look at balance sheets, or put on a blindfold and see who blows up with the temporary one time duration based rug pull.
The only problem then again, is that devaluing future dated securities through duration, is only possible by offering even higher nominal yields. The outstanding securities are worth less because we have offered people even more money in comparison. Again, bond traders are the sophisticated parties, right?
So a round of defaults comes along domestically. It can't not.
The only default that wouldn't make any sense, is a default on the national debt. That would represent not a devaluation of fiat currency, but a destruction of it. Again, waiting for the debt's valuation to fall to a defensible level, before doing any nominal hiking, is a simple alternative without requiring a complete overhaul of the institutional design of our monetary system, and the implicit contract with have with the bond market to hike rates according to inflation.
You still hike according to inflation, you just do so very modestly and in a highly delayed fashion, not because it itself reduces inflation(the defaults do that after all), but rather because it's just a pavlovian convention.
So take another hard look at the fisher equation: can we do better? yes we can!
The Process Should be Fair, not the outcomes
Banks are supposed to look at balance sheets, and by determining what assets and balance sheets have poor long term health, we can raise the standards on financial collateral. Those collateral assets which seem to be overvalued, can still go to the market for valuation, but should not be backstopped by support from a central bank. When we say "rate hiking" that is what we should be talking about: raising the standards for financial collateral, such that the worst balance sheets face higher marginal borrowing costs and a valuation decline.