Friday, March 7, 2008

Fed at Work

"In the [Fed] an independent monetary authority or a handmaiden beholden to political and market players? Has it reverted to its mistaken behavior in the 1970s? Recent actions and public comments, including Fed Chairman Ben Bernanke's testimony to Congress yesterday--where he warned of a steeper decline and suggested that more rate cuts lie ahead--leave little doubt on both counts. An independent central bank is supposed to maintain the value of the currency and prevent inflation. In the 1970s and again now, [Fed] officials repeatedly promised themselves and each other that they would lower inflation. But as soon as the unemployment rate ticked up a bit, the promises were forgotten. ... It's beginning to happen again. Unlike the response of wages and prices in the low inflation 1990s, expectations of rising inflation now delay or stop price and wage adjustment, inhibiting growth. ... Economic forecasts are not very accurate. ... But the rush to bring real short-term interest rates to negative values is an unseemly and dangerous response to pressure from Wall Street, Congress and the adminstration. The [Fed] became 'independent' in 1913 so that it could resist pressures of that kind. ... Surely Mr. Bernanke and his colleagues remember what happened in the 1970s. They console themselves with the belief that they will respond promptly to any inflation that occurs by promptly raising interest rates. That repeats the commitments made repeatedly in the 1970s, which the Fed was unwilling to keep. The blunt fact is that there is rarely a popular time to raise interest rates. And with the growing streak of populism in the country, it will become more difficult", my emphasis, Alan Meltzer (AM) at the WSJ, 28 February 2008.

"The [Fed], with its record on consumer protection already under fire, now faces questions about how well it has supervised banks. ... 'We've seen major institutions write off billions of dollars, mostly because of off-balance sheet transactions. And it's quite clear that the Fed is there on a daily basis, in all the institutions,' Sen. Jack Reed (D., R.I.) said at the hearing. It's clear, 'these banks were taking lots of risks that they didn't really see as risk. Are you ... disappointed that your regulatory apparatus didn't ... monitor the banks more closely?' Mr. Bernanke responded that the Fed needs 'to look in a much tougher way at the risk-managment procedures the banks have.' But he added, once 'they've done all the due diligence, it's hard for us to say, "That's a bad investment." That's not our role.' ... Bernanke ... rejected suggestions the U.S. could get stuck in a 1970s-style combination of high and rising inflation and stagnant growth known as stagflation: 'I don't think we're anywhere near the situation that prevailed in the 1970s. I do expect inflation to come down. If it doesn't we will have to react to it,' he said. ... The Fed has failed 'to provide the appropriate supervisory oversight for the major money-center banks,' Harvard economist Martin Feldstein wrote in a recent opinion piece in the [WSJ]", my emphasis, Greg Ip and Damian Paletta at the WSJ, 29 February 2008.

"A top [Fed] official said the central bank failed to fully appreciate risks that financial institutions were taking before the recent credit problems, and is reviewing its regulations.During a sometimes contentious Senate hearing, Fed Vice Chairman Donald Kohn said the central bank is likely to become 'more forceful' with the financial institutions it supervises. Mr. Kohn didn't explain what actions the Fed might take. ... Sen. Shelby asked Mr. Kohn is the Fed 'was afraid of the banks they regulate.' Mr. Kohn quickly responded no", my emphasis, WSJ, 5 March 2008.

AM is one of America's foremost economists in my opinion. That said, I think he is too kind to the Fed. I do not believe the Fed was ever intended to be "independent". The Fed is supposed to say things about protecting the currency's value and contain inflation it does not intend to hold to. That's window dressing. As I noted on 17 September 2007, the creation of a central bank is a plank of Karl Marx's Communist Manifesto. The Fed exists to redistribute wealth from creditors to debtors and to support the market for Treasury debt. Helicopter Ben can say whatever he wants. Ignore him.

Tell us Helicopter Ben, what is the Fed's role with respect to supervising banks which hold federally insured deposits? Why shouldn't the Fed tell the banks, it will not let them discount paper the Fed concludes is too risky? Why not publicly announce the decision not to discount such paper as soon as the Fed knows of the paper's existence? Why does the Fed not admit it creates "moral hazard" by letting the banks supposed risk management procedures control Fed policy? Who is the tail and who is the dog?

Apparently Barron's 1979 joke about the Fed chairman applies to its vice chairman too. See my 25 January 2008 post.


Anonymous said...

An independent central bank is supposed to maintain the value of the currency and prevent inflation...

True, but the Wiz of Oz has let that job fall to the FCBs and Arabs. Sweet deal.

Can Fed Prevent Inflation said...

The Fed needs to realize that it kept interest rates too low following the 2001 recession, and this was the primary driver for the housing bubble. As soon as credit and housing markets stabilize, it needs to raise interest rates again.