Yesterday, at the annual meetings of the American Economic Association, Fed Chairman Ben Bernanke offered a continued defense of the Fed’s monetary policies earlier this decade. Essentially he believes that monetary policy did not contribute to the housing bubble. He also makes clear that he believes that the excessively loose policy stance of the Fed after the dot‐com bubble burst was appropriate given the level of unemployment at that time. Given that today’s unemployment level is even worse, Bernanke has offered us a clear indication that monetary policy will remain excessively loose for the foreseeable future, regardless of the Fed’s inability to actually create jobs.
Bernanke’s remarks also illustrate the contradictions in his own thinking. At one point he comments that it would have been inappropriate for the Fed to response to increases in energy prices, because such prices were viewed as temporary; yet elsewhere he indicates that most market participants viewed house price increases as permanent, yet the Fed felt it was appropriate to ignore those, for what reason we do not know. No where in his remarks does he address the impact of ignoring the single largest item behind consumer spending: housing.
Perhaps the weakest link in Bernanke’s arguments is presenting the false choice of either monetary policy or mortgage underwriting standards. How about accepting that both played a role. Sadly when discussing underwriting standards, Bernanke continues to miss the most essential element: downpayment requirements. Nowhere in his discussion of mortgage defaults does he seem to recognize the role of equity.
The picture below, taken from a story in The Economist, shows that France, Germany, and Italy are among the nations with the most central bank employees (as a share of the population). In some sense, this is a dog‐bites‐man factoid. After all, is anyone surprised that Europe’s major welfare states have bloated public payrolls? But there’s more to this story. All three of these central banks ceased to have a monetary policy, starting back in 2002, when their nations adopted the euro. The mission is gone, but the bureaucracy lives on.
To be fair, the bureaucrats in these nations presumably are not sitting in quiet rooms playing minesweeper. Perhaps these central banks are responsible for other functions, such as financial regulation. Of course, given how governments around the world pursued policies that led to a financial crisis, perhaps all of us would be better off if bureaucrats did play computer games all day.
The Wall Street Journal reported that Congress likes Fed Chairman Bernanke, but not the institution that he heads. There is growing consensus that the Fed needs to be reformed and restructured. Most notably, there are calls to strip the Fed of its supervisory authority. In practice, the new sentiment reflects the failure of the Fed to rein in risk taking by the largest banks.
The Fed is pushing back. One reserve bank president said that removing the Fed’s supervisory authority “would affect our ability to conduct monetary authority effectively.” He went on to say that without the supervisory authority, the Fed wouldn’t know enough about risks brewing in the economy. This argument is shop worn. The Fed had the authority. It fueled the housing boom with its monetary policy and failed to head off the banking crisis with its supervisory powers. And let us not forget the regional banking crises of the 1990s; the fallout of the Latin American debt crisis for Citibank; and others (e.g., the failure of Continental Illinois National Bank). All on the Fed’s watch.
Around the world, some central banks have supervisory authority over banks and some do not. There is no clear pattern for either monetary policy or bank regulation with respect to how the powers are structured and distributed. Other factors seem to matter much more. It would be useful to identify what they are.
Congress is moving a few deck chairs around as the ship sinks. No fundamental rethinking of bank regulation is occurring. The Fed is probably being made a scapegoat for Congress’s own failings. But that is how Washington works.
Our friends at the Atlas Economic Research Foundation are offering prizes for the best essays on sound money by students and young faculty and policy analysts:
The Atlas Economic Research Foundation invites you to participate in its Sound Money Essay Contest, which has a deadline of November 24th, 2009.
The contest is open to students, young faculty, and policy writers who are interested in the cause of sound money. It aims to engage you in thinking about sound money principles with relevance to today’s economic challenges.
The overall winner will receive a cash prize of $5000. Two additional prizes of $1000 each will be given to outstanding essays written by junior faculty, graduate students, or policy writers. And three additional prizes of $500 each will be given to outstanding essays written by undergraduate students.
Essay topics include:
· “Money and the Free Society: Can Money Exist Outside of the State?”
· “The Ethical Implications of Monetary Manipulation”
· “Monetary Policy and the Rule of Law in the United States”
To be eligible, you must be a legal resident of the U.S. or engaged as a full‐time student or faculty in the U.S. You must also be no more than 35 years old on the date of the contest deadline (November 24, 2009). Atlas welcomes involvement of older and non‑U.S. scholars in its discussions and ongoing work on sound money, but this essay contest is targeted to the audience described above.
For a list of reference materials and writing guidelines, please visit the Atlas website.
And for Cato research on sound money, check here.
Many commentators have argued that if the Federal Reserve had followed a stricter monetary policy earlier this decade when the housing bubble was forming, and if Congress had not deregulated banking but had imposed tighter financial standards, the housing boom and bust—and the subsequent financial crisis and recession—would have been averted.
In a new study, Cato scholars Jagadeesh Gokhale and Peter Van Doren investigate those claims and dispute them.
In the last few days, we have witnessed an almost unprecedented chorus of warnings about inflation prospects by senior Fed officials. Dallas Fed President Richard Fisher said the Fed must be prepared to tighten monetary policy by raising short‐term interest rates with “alacrity.” President Charles Plosser of Philadelphia had spoken of the need to raise interest rates before unemployment returns to normal in order “to prevent the Second Great Inflation.” The comments of the two Reserve Bank presidents reinforce those made by Fed Governor Kevin Warsh.
Financial markets are confused because the Fed’s policy‐making committee (the Federal Open Market Committee) had just indicated its intention to keep interest rates low for an extended period. The inflation warnings represent an internal debate that has gone public. Formal dissents from the FOMCs policy directive have reportedly been discouraged. So Fed officials are in effect offering up virtual dissents in public speeches. Confidence in Chairman Bernanke’s policy is waning.
Most economic forecasters profess to see little inflation risk. They need to reconsider their forecasts in light of the inflation warnings from within the central bank.
Today President Obama took his financial reform plan to the airwaves. While there is no doubt our financial system is in need of financial reform, the President’s plan would make bailouts a permanent feature of the regulatory landscape. Rather than ending “too big to fail” — the President wants us to believe that with additional discretion and power, the same Federal Reserve that missed the boat last time will save us next time.
The truth is that the President’s plan will result in a small number of companies being viewed by debtholders as “too big to fail”. These companies would see their funding costs decline, allowing them to gain market‐share at the expense of their rivals, making these firms even larger. Greater concentration in our financial services industry is the last thing we need, yet the Obama plan all but guarantees it.
Obama also chooses myth’s over facts. The President claims that de‐regulation and competition among regulators caused the crisis. The facts could not be more different. Those institutions at the center of the crisis — Fannie Mae, Freddie Mac, Bear Stearns, Lehman –could not choose their regulator.
The President’s plan chooses convenient targets and protects entrenched interests, rather than address the true underlying causes of the crisis. At no time have we heard the President discuss the expansionary monetary policies that helped fuel the bubble. Nor has the President talked about the global imbalances — the global savings glut that poured surplus savings from the rest of the world into the US. But then the President appears to hope that loose monetary policy and continued American consumption funded by China will get him out of his own political problems with the economy. It is especially striking that the President makes little mention of the housing bubble, as if it was only the bust that was the problem.
The President continues to say he inherited this crisis. While true, he did not inherit the same individuals — Tim Geithner and Ben Bernanke — who were at the center of creating the crisis. All Obama needs to do is find a position for Hank Paulson and he will have completely re‐assembled the Bush financial team.
Without real reform — fixing Fannie and Freddie, scaling back the massive subsidies for leverage in our tax code, loose monetary policy — it will only be a matter of time before the next crisis hits. If we implement the President’s plan, we will, however, guarantee that the next crisis will be even larger and severe than the current one.