The latest “Fed Day” has now come and gone. The Federal Reserve’s decision-making Open Market Committee has issued its latest monthly pronouncement on where it will set the short-term interest rate it directly controls. (It will stay near zero, where it’s been since the end of 2008). In the process, the central bank revealed a lot about how cheap or expensive the cost of borrowing will be in the U.S. economy at least until its next meeting, in mid-December.
And as always, the effects of this Fed Day will surely ripple much wider, as many investors, businessmen, and consumers look to each new central bank monetary policy statement for clues as to the economy’s health and prospects; for indications of how the Fed will act in the foreseeable future; and for a sense of what kind of rate environment financial markets will face – a key determinant of their performance.
The run-up to the Fed's latest statement generated somewhat less suspense or anxiety (take your pick) than lately has been the case. After all, the recent slowing of the American and global economies seemed certain to have eliminated the chance of the Fed raising rates from their current levels just above zero. Chair Janet Yellen and other leading Fed lights, at least, have worried that such tightening could choke off too much growth and therefore hiring, while boosting the odds that a dangerous deflationary cycle could take hold and weaken the economy still further. (Employment and price levels are the Fed’s two main official statutory concerns – its “dual mandate.”)
Yet the statement is likely to keep raging the fierce debate in the economics, business, finance, and political communities over what the Fed should do – and what its recent unprecedentedly easy money policies have and have not accomplished so far. For the record, I favor beginning to tighten as soon as possible, for two related reasons.
First, I’ve feared that the artificial life support provided by years of Fed stimulus has so effectively masked the economy’s real weakness that the excesses that built up during the previous bubble decade (also largely enabled by the Fed) can’t undergo painful but necessary corrections. Therefore, the hard work of creating a truly durable foundation for American prosperity keeps getting postponed.
Second, even if the Fed’s gargantuan support prevented a 1930s-style depression, the credit flood it continues to supply is now actually encouraging further excesses – for reasons I spelled out in a post last month. So I’m worried that the United States – and by extension, the world, given America’s still outsized role – can’t avoid another financial crisis without tightening (i.e., starting to normalize) monetary and credit conditions; reimposing genuine market disciplines on economic activity; and making sure that risk is accurately priced (and indeed priced at all).
But as far as I’m concerned, my own views on tightening now or later are much less interesting than what this debate reveals about how well the economy’s ills are understood by both supporters and opponents of the Fed’s record these last few years. I’m simplifying a bit here, but I worry that the looser money advocates – include the apparent majority of Fed officials – are too focused on supporting growth (and hiring) literally at all costs, without thinking about the quality and sustainability of that growth. Weirdly, they appear to understand fully just how weak the economy remains, but seem to believe that all that’s possible is to prop up growth and employment indefinitely with monetary steroids.
I’m also, however, concerned about tightening arguments. Its champions seem to understand the intertwined economic and financial dangers of fostering low quality growth. But most of them appear to overestimate the economy’s underlying strength, and seem to believe that raising interest rates (at whatever pace, to whatever heights) will quickly restore genuine economic health.
Unless this paradox is somehow resolved, it’s hard to imagine recipes for solid recovery emerging that are properly targeted and based on realistic expectations of turnaround.
To be fair, neither side in this debate, much less Fed officials themselves, believes that monetary policy alone can fix the economy. Of course, the favored policies vary widely, but everyone I’m familiar with emphasizes the need for the rest of the government to start doing its part. But this observation brings up another concern. Undoubtedly, the forces that have produced and maintained D.C. gridlock are strong, and show few signs of weakening. But arguably, one of these has been the Fed itself – which may be creating a form of moral hazard in American politics.
For just as overly indulgent policies in economics and finance can convince businesses that, however massively they mess up, Uncle Sam will come to the rescue, it’s certainly possible that, at least in the backs of their minds, U.S. politicians are convinced that they can continue grandstanding unproductively because the Fed will keep the economy slogging along acceptably enough to prevent major voter backlash – and thus keep them in office.
In this vein, it’s fascinating – and a little disturbing – that former Fed Chair Ben Bernanke has also just suggested a belief that the Fed can and should back stop dysfunctional governing systems. In an interview last week with the Financial Times, Bernanke stated that “One of the Federal Reserve’s key functions is to act quickly and proactively when the legislative process is too slow.” Although the central bank was structured to be independent of short-term political considerations and pressures from office-holders, I’ve never heard anyone ever aver that the Fed should in any way substitute for elected politicians.
Does Bernanke’s successor, Yellen, agree? She’s scheduled to appear before Congress in early December. Maybe someone could ask?
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