In today´s NYT Sunday Review, David Leonhardt writes “Dissecting the Mind of the Fed”:
IF you were to conduct a survey of the country’s top economists, you would find a fair number who did not believe that the Federal Reserve should be taking more aggressive steps to help the economy. Some would worry that injecting more money into the economy might unnerve global investors or set off uncontrollable inflation. Others would wonder whether, with interest rates already so low, the Fed even had much power to lift economic growth.
But you would also find a sizable group of economists who thought the Fed could and should do far more than it was doing.
You would never know this, however, from listening to the public debate among Federal Reserve officials. That debate is much narrower.
On one side are people like Ben S. Bernanke, the Fed chairman, who defend both what the Fed has done and what it hasn’t done. On the other side are the so-called inflation hawks, who say the Fed has been far too aggressive. Rick Perry, the Texas governor and arguably the Republican presidential front-runner, offered a particularly blunt version of this criticism when he recently accused Mr. Bernanke of flirting with treason.
It is obviously impossible to know precisely which policy would be the best one for the struggling American economy. A dovelike injection of money into the economy would have the potential to increase incomes and inflation in a benign way, effectively reducing household debt burdens, giving people more confidence to spend money and eventually spurring hiring. But further action also brings some risk of setting off uncontrollable inflation, which, while very low historically, has been rising lately.
No doubt, some of this richer hawk-dove debate is occurring behind closed doors at the Fed and in Jackson Hole. But the public conversation still matters. It affects nothing less than the Fed’s credibility. Mr. Bernanke knows that if he errs on the side of passivity — worrying more about inflation risks than unemployment — he risks only a modest flogging from colleagues and politicians. If he leans the other way, he risks being accused of, well, treason.
That´s the sort of stupid and narrow minded debate that helps, more than anything else, keep the economy in deep sh–, unemployment high and future prospects bleak. Everything, and absolutely everything, has to be sacrificed so that inflation (which one no one knows for sure) stays in the 1% – 2% range.
And that “inflation obsession” was exactly the reason for the economic woes the US is going through today. Many keep harping on the fact that monetary policy is “easy” by looking at “zero” interest rates although they know, or should know, that interest rates are a lousy indicator of the stance of monetary policy. And Bernanke thinks that by communicating that policy rates will remain at “zero” for another two years is tantamount to an “easing” of monetary policy!
This quote from Macroeconomic Advisers “FOMC chatter ahead of the September 2008 meeting” on September 12, 2008 is illustrative, effectively arguing that monetary policy was restrictive (my bolds):
Over the period that ended in April 2008, the FOMC strategy was to ease aggressively in order to offset the tightening of financial conditions arising from wider credit spreads, more stringent lending standards, and falling equity prices. We said that the FOMC was “running to stand still”, in that those actions did not create accommodative financial conditions but were needed to keep them from becoming significantly tighter. Since the last easing (April 2008), however, the FOMC has abandoned that strategy. Financial conditions have arguably tightened more severely since April than during the earlier period, and yet there has been no policy offset. This pattern has contributed importantly to the severe weakening of the economic outlook in our forecast.
During 2007 financial conditions worsened, and as the picture below shows, monetary policy was able to keep spending close to its “target” (“running to stand still”). Once the strategy changed, monetary policy was effectively tightened (despite the “low” level of the Funds rate) and the economic deterioration was almost immediate and severe, further worsening financial conditions and contributing to the Lehman Brothers affair!
The most obvious reason for the change in “strategy” is provided by the picture that depicts inflation, both in its “headline” and “core” versions. The Fed was “duped” into tightening MP from the rise in commodity and oil prices. This is surely another indication that “inflation targeting can be hazardous to the economy´s health”.
The Fed, through a number of “special programs”, feeling it has “saved the financial system, thus avoiding a second Great Depression”, is content to let the economy (spending) evolve along a much lower growth path, no matter the effects on employment and more general economic prospects. A “screwed up mind” indeed!