Central Banks and Financial Turmoil

January/​February 2017 • Policy Report

Cato’s Center for Monetary and Financial Alternatives hosted the 34th Annual Monetary Conference in November, drawing a crowd of over 200 people. Cato’s vice president for monetary studies Jim Dorn, who, as always, organized the event, opened the conference by laying out the crucial questions at hand: Why have interest rates stayed so low for so long? What will the long‐​run impact of the Fed’s post‐​crisis policies be on financial markets? Is the recent strength of equity markets driving Fed policy, or is the Fed the cause of that strength? What happened to the monetary transmission mechanism after the crisis? “We’re in uncharted monetary waters, to be sure, since the unconventional monetary policies entered with the financial crisis,” he said.

Thomas M. Hoenig, the vice chairman of the Federal Deposit Insurance Corporation, gave the keynote address, in which he argued that monetary policymakers are overly focused on short‐​term economic performance, at the expense of long‐​term goals. This, he said, has created more economic uncertainty and fragility. He also discussed macroprudential regulation, saying that, rather than correcting the Fed’s mistakes, it has only worsened moral hazard and the misallocation of capital.

In the luncheon address former chair of the Senate Banking Committee Phil Gramm debunked common myths—the “accepted view”—about the recession. “Most of what you ‘know’ is not so,” he said. In particular, he denounced the idea that banks had been “deregulated” in the decades before the crisis as “totally and absolutely false.” In fact, he argued, there were four major banking bills in the quarter‐​century prior to the crisis—the Competitive Equality Banking Act, the Financial Institutions Reform, Recovery, and Enforcement Act, the Federal Deposit Insurance Corporation Improvement Act, and Sarbanes-Oxley—that greatly expanded the power of financial regulators. He also contended that Gramm‐​Leach‐​Bliley (of which he is the “Gramm”), which repealed parts of Glass‐​Steagall, made the financial system more stable, not less, by allowing for diversification. As for the recovery, Gramm blamed a regulatory system that turned banks into “public utilities.”

In a panel on central banking and market volatility, James Grant, the editor of Grant’s Interest Rate Observer, argued that the Fed serves as a “safe space” for Wall Street, protecting it from the volatility of a truly free market. MIT’s Athanasios Orphanides, former St. Louis Federal Reserve Bank vice president Daniel Thornton, and former Federal Reserve Board governor Robert Heller joined moderator Josh Zumbrun of the Wall Street Journal for a panel on monetary mischief and the “debt trap,” where Thornton argued that the U.S. government deficits since the 1970s are symptoms of Keynesian thinking which has encouraged easy monetary policy and deficit spending.

A final panel featuring former Cleveland Fed president Jerry Jordan, Steve Hanke of Johns Hopkins, and Walker F. Todd of the American Institute for Economic Research discussed rethinking the monetary transmission mechanism. Other speakers included former BB&T CEO John Allison, Kevin Dowd of Durham University, Tyler Goodspeed of the University of Oxford, and Gerald O’Driscoll of the Cato Institute.