“Grand Central Productions” presents: “Fed Warms to Notion of Using Rates to Fight Bubbles”
A sample of the dialogue (it´s in the “we said” – “he said” – “what does it mean” format):
1) WE SAID: Easy monetary policy might be a source of financial bubbles. If so, monetary policy can’t be dismissed as a tool to prevent financial instability.
HE SAID: “The worry is that the actual extended period of low interest rates, along with expectations fostered by forward guidance of continued low rates, may be incentivizing financial market actors to take on additional risks to boost margins, thereby contributing to unsustainable increases in asset prices and a consequent buildup of systemic vulnerabilities. Indeed, in the years preceding the crisis, a few prescient observers swam against the tide of conventional wisdom to argue that a sustained period of low rates was inducing investors to ‘reach for yield’ and thereby endangering the financial system.”
I would call the question “leading the witness”, but let´s ignore that. The tacit understanding is that “easy” policy means low interest rates. And “easy” monetary policy brings out the worst in people.
3) WE SAID: Monetary policy finds problems that regulators can’t. As Fed governor Jeremy Stein says, “Monetary policy may not be quite the right tool for the job, it has one important advantage relative to supervision and regulation–namely that it gets in all of the cracks.”
HE SAID: “Macroprudential policies could not be viewed as a substitute for monetary policy … they would influence a narrower set of transactions and, as such, would not ‘get in all the cracks’ of the financial system.”
More likely, “monetary policy creates problems that regulators (if they are doing a decent job) can´t”.
As I wrote recently on that “diploma-loosing” remark by Harvard´s Jeremy Stein, it´s like saying that interest rates have “drone capabilities” (“Find them wherever they are and kill them!”). Macroprudential policies are more akin to regular “foot soldiers” that would not get in all the cracks of the “target area”.
WHAT IT MEANS: Mr. Tarullo, a central player in this debate, sees macroprudential policies as a speed bump to slow the advance of financial excess, but argues that “monetary policy action cannot be taken off the table as a response to the build-up of broad and sustained systemic risk.” Put another way, if a new bubble emerges, Fed officials will be considering whether they need to stamp it out with higher rates.
Yes, by all means do it, no matter that you would likely “throw the baby out with the bathwater”.
The 2008 transcripts paint the FOMC in a Quixotic fight against an imaginary inflation evil. All along it is said that policy is “accommodative”. In his “valedictory” speech Rick Mishkin tried hard to dispel member’s ingrained notion that the Fed Fund rate is a good indicator of the stance of monetary policy. Even Mishkin over the last few years, maybe not to feel isolated, has moved closer to the “dark side” (this story is told by the subtle changes in the revisions to his famous Money and Banking textbook).
If not interest rates, what could measure the stance of monetary policy? Several years ago during a conference celebrating the legacy of Milton and Rose Friedman Bernanke himself gave a hint:
The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman . . . nominal interest rates are not good indicators of the stance of policy . . . The real short-term interest rate . . . is also imperfect . . . Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.
And that´s exactly what I´ll do, but only in my next post, which I´ll write during the pagan celebrations called Carnival, that starts warming up tomorrow and then heats up to Tuesday´s climax!