Tag: Federal Reserve

Bernanke’s Soft-Core Keynesianism Is Even Worse than the Nonsensical Analysis of Hard-Core Keynesians

Earlier this week, the Washington Post predictably gave some publicity to the Keynesian analysis of Mark Zandi, even though his track record is worse than a sports analyst who every year predicts a Super Bowl for the Detroit Lions. The story also cited similar predictions by the politically connected folks at Goldman Sachs.

Zandi, an architect of the 2009 stimulus package who has advised both political parties, predicts that the GOP package would reduce economic growth by 0.5 percentage points this year, and by 0.2 percentage points in 2012, resulting in 700,000 fewer jobs by the end of next year. His report comes on the heels of a similar analysis last week by the investment bank Goldman Sachs, which predicted that the Republican spending cuts would cause even greater damage to the economy, slowing growth by as much as 2 percentage points in the second and third quarters of this year.

Republicans understandably wanted to discredit this analysis. But rather than expose Zandi’s laughably inaccurate track record, they asked the Chairman of the Federal Reserve, Ben Bernanke, for his assessment. But this is like asking Alex Rodriguez to comment on Derek Jeter’s prediction that the Yankees will win the World Series.

Not surprisingly, as reported by McClatchy, Bernanke endorsed the notion that spending cuts (actually, just tiny reductions in planned increases) would be “contractionary.”

Bernanke was asked repeatedly about GOP proposals to trim anywhere from $60 billion to $100 billion in government spending during the current fiscal year, which ends Sept. 30. These cuts would do little to bring down long-term budget deficits but would slow the economic recovery, he cautioned. “That would be ‘contractionary’ to some extent,” Bernanke said, projecting that “several tenths” of a percentage point would be shaved off of growth, and it would mean fewer jobs. …While Democrats got what they wanted out of Bernanke with that answer, he frowned on some of their projections that the spending cuts that are being debated could reduce growth by a full 2 percentage points.

Since he is not a fool, Bernanke was careful not to embrace the absurd predictions made by Zandi and Goldman Sachs. But that’s merely a difference of degree. Bernanke’s embrace of Keynesian economics is disgraceful because he should know better. And his endorsement of deficit reduction (at least in the long run) is stained by crocodile tears since Bernanke supported bailouts and endorsed Obama’s failed stimulus.

But while Bernanke is not a fool, I can’t say the same thing about Republicans. Bernanke has made clear that he either believes in the perpetual-motion machine of Keynesianism, or he’s willing to endorse Keynesian policies to curry favor with the White House. Republicans should be exposing these flaws, not treating Bernanke likes he’s some sort of Oracle.

Johan Norberg on Bubbles Yet to Come

Cato senior fellow Johan Norberg, author of In Defense of Global Capitalism and Financial Fiasco, has the cover story in this week’s issue of The Spectator, the eminent 182-year-old British weekly. Titled “The great debt bubble of 2011,” it warns that governments are repeating their mistakes of the past decade:

There is a broad consensus that the financial crisis of 2007 was at least in part a result of record-low interest rates, huge deficits and large-scale credit-financed consumption. Today, governments across the world are trying to solve the crisis — by means of record-low interest rates, huge deficits and large-scale credit-financed consumption. This time, they are also using more novel means of creating easy money: bank bailouts, stimulus packages and quantitative easing.

After discussing the soaring debt burdens of European countries, Norberg writes:

At this point, it is traditional to say: thank God for those roaring economics in East Asia, India and Brazil. But how real is their remarkable growth? Look closely, and even this may be in part a result of artificial stimulus. India’s and Brazil’s growth is financed by short-term capital from abroad: money that could disappear overnight. Easy money always ends up somewhere. The last time it was in property, this time it is in emerging markets (and often in the property markets of emerging markets)….

Aside from the foreign capital inflows, China had its own stimulus package, as big as America’s. Beijing has printed yuan and pushed banks and local governments to spend like drunken Keynesians. Absurdly, China’s money supply is now larger than America’s, even though its economy is a third of the size. We can see the results of this stimulus in stock market prices and in new roads, bridges and housing complexes all over the country.

Happy New Year! And watch for more on incipient bubbles in the January-February issue of Cato Policy Report.

Is the Federal Reserve Heading Towards Insolvency?

A recent statement from the Shadow Financial Regulatory Committee, points out that both rounds of quantitative easing by the Federal Reserve have dramatically altered the maturity structure of the Fed’s balance sheet.  Normally the Fed conducts monetary policy using short-term Treasury bills, which allows the Fed to avoid most interest rate risk.  In loading up its balance sheet with long-dated Treasuries and mortgage-backed securities, the Fed has exposed itself to significant interest rate risk.

Recall that the yield, or interest rate, on a long term asset is inversely related to its price.  So if you’re holding a mortgage that yields 5% and rates go up to 6%, then the value of that mortgage falls below par.  The same holds for Treasury securities.  I think  it is a safe assumption that rates will be higher at some point in the future.  When they finally do rise, and if the Fed still maintains a large balance sheet of long-dated assets, those assets will suffer losses.

Of course the Fed is not subject to mark-to-market rules and can avoid admitting losses by holding these assets to maturity.  But if the Fed, at some point in the future, wants to fight inflation, the most obvious way of doing so would be to sell off assets from its balance sheet.  It is hard to see the Fed engaging in substantial open-market operations without using its long-dated assets.  But if it is to sell these assets, it will have to do so at a loss (once again, because of higher rates).

Now the Fed claims to have other avenues by which to tighten, besides open-market operations.  For instance, it can raise the interest rate on excess reserves.  But then this would further erode the value of assets on its balance sheet.  Not to mention that they have to find the money somewhere to pay these higher rates on reserves.

Ultimately the Fed can continue to pay its bills, not out of earnings from its balance sheet, but by electronically crediting the accounts of its vendors and employees, but that would also be inflationary.  The real danger, again pointed out by the Shadow Committee, is that the Fed may avoid raising rates in order to minimize the losses embedded in its balance sheet.  One of the very real dangers from QE1 and QE2 is that the Fed has exposed itself to potential losses that are correlated with any efforts to fight inflation, raising serious questions as to its willingness to fight inflation.

Is Ron Paul Good for Monetary Policy?

Now that Ron Paul has gained the chairmanship of the Subcommittee on Domestic Monetary Policy, the spin has begun that this victory will be an empty one.  Some even suggest that libertarians should be, and are, opposed to Paul.

I have to admit I was a bit surprised when Dave Weigel of Slate placed me in that category.  While I expressed concern regarding Paul’s communications skills, the fact is that while he isn’t the best choice in Congress to take on the Fed, he is the only choice.  Any other Congressman would simply continue to ignore the long history of failure associated with the Fed.  Had Dave presented a fuller picture of our conversation, that would have been clear.

Back to the question at hand, Paul will ultimately be good for monetary policy because he will actually bring some oversight to the Fed, which has been sorely lacking.  Under the current Democrat Chair Mel Watt, this subcommittee has held a total of five hearings all Congress, and none of them were actually on monetary policy.  Two of these hearings weren’t even on areas under the jurisdiction of the Federal Reserve.  Republicans have not done much better when they were previously in charge. 

Much has been made of a recent Bloomberg poll showing that a majority of Americans want the Fed either abolished or reined in.  While that poll offers hope, those of us who ultimately want to end the Fed, should remember that only 16 % wanted the Fed abolished.  While 39% want the Fed to be more accountable, that does not constitute ending the Fed.  What Ron Paul can most accomplish over the next two years is helping to educate that 39% on why minor tweaks will not make the Fed accountable. 

Some have suggested that Ron Paul does not present the right face for taking on the Fed.  But the fact remains that if not Paul, who?  Given that Paul is about the only one in Congress willing to fight this fight, he merits support, even if that support is occasionally critical.

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Is There an Inflation-Unemployment Trade-off?

Much of what drives the policy choices of Ben Bernanke and the Federal Reserve is a belief in the ability to trade higher inflation for lower unemployment, known within the economics profession as the “Phillips curve.”   But does this trade-off actually exist? 

While its true that many have found a negative correlation between inflation and unemployment prior to 1960, looking at U.S. data, this relationship appears to have broken down in the mid-1960s, just about the time policy-makers thought they could exploit it (Lucas critique anyone?).

It is hard, looking at the graph, which displays the annual change in consumer prices over the previous year and unemployment, to see much of a relationship.  In fact, since 1960, the correlation between changes in CPI and unemployment has been positive.  We have generally seen rising unemployment along with rising inflation.  Of course, one might be concerned that the stagflation of the 1970s is driving this result. But looking at the data since 1980, there still remains a positive correlation between inflation and unemployment.  While I am not arguing that inflation causes unemployment (after all, correlation is not causation), it should be clear from the data that there is not some exploitable trade-off that policymakers get to choose.

The Richmond Fed also has a great history of the Phillips curve that is well worth the read.  Perhaps Fed President Jeff Lacker should bring copies to the next FOMC meeting.

Boehner to Protect the Fed?

With Republicans taking control of the House in January, long-time Federal Reserve critic Rep. Ron Paul is in line to take over chairmanship of the House Financial Service Committee’s Subcommittee on Domestic Monetary Policy and Technology.  This is the subcommittee with direct oversight of the Federal Reserve.

The thought of having some actual oversight of the Fed is apparently making Wall Street and the rest of the banking industry nervous.  Recent disclosures of Fed lending to foreign banks and Wall Street did not help the public image of either Wall Street or the Fed.  With Congressman Paul pushing for a full audit of the Fed, it is likely even dirtier secrets of the Fed may come to light.

So where have the Fed and Wall Street turned for protection?  According to Bloomberg, the Fed’s new protector might be incoming House Speaker John Boehner.   Next week, House Republicans meet to select their committee and subcommittee chairs.  Bloomberg sources report that, at the request of the major banks, Boehner is looking for avenues to either deny Paul that subcommittee chair or to restrict his ability to oversee the Fed. 

While I always expected the House Republicans to eventually revert back to their old ways, I did think they’d at least wait until 2011.  I believe this will be a real test of Boehner:  Does he choose to rein in Ron Paul or rein in the Federal Reserve?