George Washington Blog
Sunday, September 27, 2009
Let’s put aside for a moment allegations that the Federal Reserve has manipulated the markets.
And let’s put aside for a minute claims that the Federal Reserve System creates trillions of dollars in unnecessarily debt for the U.S. government and American people that would not be incurred if the government took back the “power to coin money” granted to the government itself in the Constitution.
Let’s look at the Fed’s actual performance and determine how bad – or good – the Federal Reserve has really been for America.
Many also blame the Fed for blowing an unsustainable bubble between 2001-2007 through artificially low interest rates. If this sounds too much like an Austrian economics perspective, that may be true. But remember that Hayek won the Nobel prize in 1976 partly for arguing that artificially low interest rates lead to the misallocation of capital and to bubbles, which in turn lead to busts.
(ARTICLE CONTINUES BELOW)
Moreover, one of the Fed’s main justification has been that it can provide a “counter-cyclical” balance. In other words, during boom times it can put on the brakes (“take the punch bowl away right as the party gets started”), and during busts it can get things moving again. But as economist Jane D’Arista has shown, the Fed has failed miserably at that task:
Jane D’Arista, a reform-minded economist and retired professor with a deep conceptual understanding of money and credit [has a] devastating critique of the central bank. The Federal Reserve, she explains, has failed in its most essential function: to serve as the balance wheel that keeps economic cycles from going too far. It is supposed to be a moderating force in American capitalism on the upside and on the downside, the role popularly described as “leaning against the wind.” By applying its leverage on the available supply of credit, the Fed can slow down a boom that is dangerously overwrought or, likewise, stimulate the economy if it is sinking into recession. The Fed’s job, a former chairman once joked, is “to take away the punch bowl just when the party gets going.” Economists know this function as “counter-cyclical policy.”
The Fed not only lost control, D’Arista asserts, but its policy actions have unintentionally become “pro-cyclical”–encouraging financial excesses instead of countering the extremes. “The pattern that has developed over the last two decades,” she wrote in 2008, “suggests that relying on changes in interest rates as the primary tool of monetary policy can set off pro-cyclical foreign capital flows that tend to reverse the intended result of the action taken. As a result, monetary policy can no longer reliably perform its counter-cyclical function–its raison d’être–and its attempts to do so may exacerbate instability.”…
The Fed is also supposed to act as a regulator for banks and their affiliates, but failed miserably in that role as well.
Indeed, that central bankers’ central banker – BIS – has itself slammed the Fed:
In a pointed attack on the US Federal Reserve, [BIS and its chief economist William White] said central banks would not find it easy to “clean up” once property bubbles have burst…
Nor does it exonerate the watchdogs. “How could such a huge shadow banking system emerge without provoking clear statements of official concern?”
“The fundamental cause of today’s emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low,” [White] said.
The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning…
“Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.
“To deny this through the use of gimmicks and palliatives will only make things worse in the end,” he said.
The above list is only partial. But even without market manipulation or unnecessary interest charges, it shows that the Federal Reserve has performed very poorly indeed.
This article was posted: Sunday, September 27, 2009 at 6:09 am