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The Fed is clearly ignoring its dual mandate. After the last meeting they basically admitted as much:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

In a previous post, this is how I responded:

We expect to fail, but we’ll keep a close watch on things just to make sure.

Yet the inflation rate is close enough to their informal target that lots of average people are being fooled into thinking the Fed is “doing its job.” But not the experts. Here is James Hamilton’s reaction:

In almost identical language that it used November 2, the Fed is saying that it expects unemployment will remain higher than it wants, inflation will likely be lower than it wants, and that it has significant concerns about where events in Europe might lead. In normal times, that trio would surely signal that policy would become more expansionary. But the Fed opted instead to keep things more or less on hold, again using almost identical language as in its previous statement:

I vaguely recall similar statements made at various times by progressives like Krugman, DeLong, Yglesias, etc. It’s very clear what’s going on here.

Unfortunately there is a long delay in releasing the minutes from Fed meetings. When the minutes for the November 1937 meeting were released, we learned that the Fed was almost criminally negligent. They had doubled reserve requirements earlier in the year. Now the economy was clearly sliding into a deep slump. But they did not reverse course. One governor indicated that if they cut reserve requirements the Fed would be embarrassed, as its previous decision would look incorrect–thus putting his “feelings” ahead of the welfare of millions of cold, hungry and unemployed men and women.

I expect similar revelations from the minutes of the past four years. Just consider the slump in NGDP between June and December 2008. There was the August meeting where Fisher voted for tighter money. The meeting after Lehman failed in mid-September, where the Fed refused to cut rates out of fear of inflation, even as TIPS spreads (correctly) showed 1.23% inflation over the next five years. The decision to raise the interest rate on reserves to roughly 1% in November 2008, in a successful attempt to keep excess reserves bottled up in the banking system. All the various decisions not to use their ammunition, despite the obvious need for more demand.

Some will argue the Fed’s doing a good job; that it’s all about low inflation. Unfortunately, the Fed itself does not agree. Frequent commenter Benjamin Cole has an eloquent post over at Lars Christensen’s blog. Here he points out that there’s never been anything magical about 2% inflation:

The United States economy flourished from 1982 to 2007″”industrial production, for example, doubled, while per capita rose by more than one-third””while inflation (as measured by the CPI) almost invariably ranged between 2 percent and 6 percent. That is not an ideology speaking, that is not a theoretical construct. It is irrefutably the historical record. If that is the historical record, why the current hysterical insistence that inflation of more than 2 percent is dangerous or even catastrophic?

The Fed has frequently eased monetary policy when inflation was well above 2%, most recently in late 2007 and early 2008. You might argue that those easings were done in response to fear of a banking crisis. That’s right, they’re willing to ease to help the banks, but not to help the unemployed. BTW, employment is part of their dual mandate, banks aren’t.

You might wonder how I can be so sure that the Fed minutes will expose all sorts of embarrassing admissions. It’s not hard at all, just look at what Fed officials are saying publicly. Marcus Nunes directs us to a recent speech by Richard Fisher. Here’s a passage he didn’t quote:

My colleague Sarah Bloom Raskin””one of the newest Fed governors, and a woman possessed with a disarming ability to speak in non-quadratic-equation English””recently used the example of the common kitchen sink to illustrate a point. I am going to purloin her metaphor for my description of our present predicament. You give a dinner party. The guests leave and you are washing the dishes. When you are done, you notice the remnants of the party are clogging the sink: bits of food, coffee grinds, a hair or two and the like. You have two choices. You can reach down and scoop up the gunk, a distinctly unpleasant task. Or you can turn the water on full blast, washing the gunk down the drain, providing immediate relief from both the eyesore and the distasteful job of handling the mess. You look over your shoulder to make sure your kids aren’t looking, and, voilÃ , you turn the faucet on full blast, washing your immediate troubles away. From my standpoint, resorting to further monetary accommodation to clean out the sink, clogged by the flotsam and jetsam of a jolly, drunken fiscal and financial party that has gone on far too long, is the wrong path to follow. It may provide immediate relief but risks destroying the plumbing of the entire house.

Fisher would have been quite at home on the Herbert Hoover Fed.

Fisher’s speech produces two reactions. First, how could he be so clueless about monetary policy. But when you stand back and start to think about what it all means, a second question begins to emerge. Why are such fools allowed on the FOMC? How is it that the world’s greatest economic policy institution, the central bank that tends to set the tune for world aggregate demand, is managed by people who are so obviously incompetent? Let’s see where we can connect the dots:

1. Stiglitz develops a theory that unemployment is caused by rapid technological change, which makes workers redundant. This in some mysterious way reduces aggregate demand.

2. Stiglitz meets with Obama, to offer a Nobel Prize winner’s expert advice on our predicament.

3. Christy Romer and Larry Summers are horrified to find Obama spouting theories that the unemployment problem isn’t lack of demand, rather it’s ATM machines stealing jobs. Christy Romer can’t convince Obama that the Fed still has ammunition.

4. Obama never pays any serious attention to the Fed. When the Dems had a filibuster-proof majority in the Senate, he fails to even nominate people for several positions for a period of 18 months. Even today he is ignoring the problem, several seats remain empty.

The following quotation is from Fisher, but it might just as well have been Stiglitz:

My reluctance to support greater monetary accommodation has been based on efficacy: With businesses’ cash flow””driven by record high profits and bonus depreciation””at an all-time high, both absolutely and as a percentage of GDP; with every survey, including those of small businesses, indicating that access to capital is widely available and attractively priced;[6] with balance sheets having been amply reconfigured; and with bankers and nondepository financial institutions sitting on copious amounts of excess liquidity, I have argued that further accommodation was unlikely to motivate the private sector to put people back to work. It might even prove counterproductive should it give rise to fears the Fed is so hidebound by academic theory as to be blind to the practical consequences of harboring an ever-expanding balance sheet. This inevitably raises concerns we are creating distortions in the fixed income markets that inhibit proper market functioning, or concerns that””despite our protestations to the contrary””we are given to monetizing the government’s debt, an impulse that ultimately destroys a central bank’s credibility. I have argued that other, nonmonetary factors are inhibiting the robust job creation we all seek.

Monetary policy is one of those areas where the fringe right and the fringe left meet and shake hands. And right now they are influential enough to prevent the Fed from doing what it knows needs to be done. Not powerful enough to prevent all action—the Fed will prevent deflation, I have no doubt about that. But powerful enough to prevent the Fed from fulfilling their dual mandate. History will see all this very clearly, and judge the Fed harshly. How ironic after Bernanke promised Milton Friedman that the Fed would never repeat the errors of the Great Depression. How ironic after Bernanke eloquently spoke out against the passivity of the Bank of Japan (an institution that also cut rates to zero and did massive QE.)

On a positive note, Fisher will be off the FOMC in January.

HT: Morgan Warstler

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This entry was posted on December 18th, 2011 and is filed under Crisis of 2008, Great Recession, Inflation, Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



