The Sleepy, Reckless Fed

A guest post by Benjamin Cole

The somnolent United States Federal Reserve is taking large and uncalculated risks in its current policies, possibly inviting another and even more-sustained recession.

Sleeping at the wheel is reckless.

As we saw in the first quarter, the U.S. real economy is hardly a bull, shrinking at a 2.9 percent annual rate. The blame is falling on (regional) bad weather. However, the U.S. had bad weather back in 1985 and 1996, but no 2.9 percent drop in real output.

Can the Fed Wake Up?

Few have connected the Fed’s scaling back its quantitative easing (QE) program with the Q1 plunge. Maybe a direct line cannot be drawn. But surely there is a connection between the deathly pall of Q1 and a Fed that sleepwalks towards its putative goal of 2 percent inflation, while the idea of robust real growth becomes but a daydream of years and leadership gone by.

As noted by many, the Fed after 2008 has been content with just the minimum amount of stimulus to prevent outright deflation—similar in that regard to the Bank of Japan, through most of the island nation’s gloomy and mildly deflationary 1992-2013 years.

Minutes of Federal Open Market Committee (FOMC) consistently reveal the 12-member board had little but inflation scares, even as Americans lost jobs and business went under on a scale unmatched since the Great Depression. Reading the public pronouncements of many of the FOMC members confirms suspicions that many regard real economic growth of secondary concern, if that.

The Fed, as an institution, refuses to wake up.

Reckless Slumber

Yet the gathering risk throughout the last six years has been another recession, and never rising inflation, by any meaningful measure. Indeed, until very recently there has been outright deflation in U.S. unit labor costs, even as inflation-hysterics manically hammered at klaxon with hammers.

In fact—as so often and expertly graphed in this space by Marcus Nunes—the last six years have weakest recovery from a recession since WWII. And (again, as recently noted in this space) sharp contractions in real and nominal GDP—as we saw in the first quarter—are often associated with actual or pending recessions.

By somnolent dithering, the Fed may soon wake up to a catastrophe, and that is a recession when interest rates are already dead and the Fed already publicly committed to snuffing the QE program entirely.

No More Comfy Snoozes at the Fed?

If another recession breaks the nap, the Fed may face a couple egg-face options: 1) Reverse course, admit to a basic and huge policy error, and go back to QE, or 2) Do nothing, go back to sleep, and wait for a few years until a change in leadership will allow “QE with honor.”

Or perhaps (or probably) the Fed bankers will choose another option in a new recession: Assert the Fed has a single mandate, that of zero inflation, and that as an institution it is succeeding brilliantly.

That is the dream of central bankers everywhere!

4 thoughts on “The Sleepy, Reckless Fed

  1. This seems to be a global problem. ECB seems to be the worst offender but what is causing this whole mess. It’s like central banks have somehow forgotten what their purpose is. In euro area this thing is painful to watch, the damage they do nations and their people.

    After ERM disaster I never thought that something like this could ever happen. But it’s not happening only here, it’s happening also elsewhere less intensively. I hope that Fed and ECB would just reverse course, tomorrow. Say that they were mistaken and now they are ready to do their job. But that won’t happen.

    • Mr. Maatta–

      Thanks for your comment. Bad news: It took 20 years for the Bank of Japan to change its tune.

      Perhaps my next post will be about public organizations and the people who get hired and stay on. Ask anyone in the Defense Department should we have a bigger national security budget, and they will all say “yes.” There are dangers everywhere, globally, always getting worse.

      Ask any social welfare worker is life unfair, and they will all say “yes.” The government should help people, who are never lazy or undisciplined.

      Ask any central banker should money be tight, and they will all say “yes.” Central bankers are not entrepreneurs, or real estate developers, or retailers, or venture capitalists. They are mandarins, controllers.

      I also observe (cynically), central bankers pay is not tied to growth. They have sinecures, In fact deflation benefits central banker staffs.

      It would be interesting to tie central banker pay to real GDP growth.

  2. Central bankers are indeed negligent, perhaps even criminally so. But we have to take a look at the politicians and processes that put them where they are – it is their fault for allowing this to continue nearly unabated. In the US, Obama owns this for not exercising his removal power to remove governors who should not be on the FOMC, or at least threatening it, leaving BoG seats empty aloowing the bankers to take over, and appointing people who want to see monetary policy get into all the cracks when he finally does fill a seat. Obama has been and is an unmitigated economic disaster.

    • Dajeeps–

      Thanks for commenting. Yes, Obama is clueless about the Fed—and that is being nice about it. In some ways, I “excuse” Obama. A President a cannot understand everything, from national defense, to health care to monetary policy.

      I think Obama was poorly advised. It is easy to see why Obama knows nothing. Who is (besides Market Monetarists) calling for a growth-oriented Fed? You have the Krugmans crying about federal stimulus, and the right-wingers screaming for tight-money.

      Almost no one says, “Cut federal spending and open up the Fed like Niagara.”

      For five years I have called for an aggressive, growth-oriented Fed. To err on the upside, tolerate some inflation etc. Even fellow MM’ers regard me as suspect.

      I think I was right.

      Yes, Obama gets an “F” on monetary policy. But so does 90 percent of the “profession” of economics.

      BTW–the above is another reason to move Fed operations into the Executive Branch. The public might better understand who is accountable.

      Right now, who understands anything about the Fed? 1 percent of the public? So Obama gets a pass.

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