By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
The YouTube video “Quantitative Easing Explained” has surpassed 2.9 million views. The video is both entertaining and unremittingly critical of the Fed. In defense of the Fed, numerous economists, bloggers and mainstream media pundits have pointed out errors in the video. In doing so, the critics have missed the forest for the trees. While there are errors and oversimplifications in the video, it has resonated with the public because: a) it tapped into widely held perceptions about the Fed and b) the video deftly treated troublesome aspects of Fed policy with comedic license.
In fact, the defensiveness of the critics of the video has only served to convince many skeptics of QE2 that its proponents are unwilling to or incapable of seeing the troublesome dimensions attached the bailout packages and the decision to go forward with QE2. The critics of the video and the Fed itself also appear unaware of how much the stature of the Fed has suffered as a result of the financial crisis, the recession, and the bailouts. It behooves the Fed and its defenders to move past narrow definitional/legalistic responses and address the underlying concerns of many citizens and market participants.
Two examples of criticisms of the video that miss the forest for the trees are the responses to:
1. The assertion in the video that engaging in QE2 equates to printing money, and
2. The suggestion in the video that the Fed should buy Treasuries directly from the Treasury.
The Fed does not print money. It never has. Furthermore, the reserves that had been created as a result of QE are not included in the monetary aggregates. On the other hand, the Fed has by expanding its balance sheet contributed to inflation in the past and reserves are part of both the monetary base and “high-powered money”.
However, the import of the video does not turn on whether or not QE2 will create money or reserves. QE2 is presented as part of a long litany of Fed policy mistakes. Some of the mistakes are mentioned explicitly in the video, i.e., the Fed’s contribution to the housing bubble and its failure to appreciate the magnitude of the subprime crisis. Viewers will also have in mind the Fed’s failure to carry out its bank regulatory and supervisory responsibilities. Equating QE2 with printing money and policies of “banana republics and failed economic systems” is a short-hand humorous way of invoking the laundry list of costly failures in the minds of the viewers. Arguing a definitional point, reserves are not money, and ignoring policy failures misses the point.
While the critics correctly point out that the Fed is prohibited by law from buying new issues directly from the Treasury, they again missed the point. Main Street is deeply troubled by the Fed’s decision to play roles heretofore filled by the fiscal authorities and the bankruptcy courts. The video is a general protest against the role the Fed has played in transferring wealth from savers and taxpayers to Goldman Sachs and other Wall Street firms. The Fed is seen as picking winners and losers: Wall Street is seen as the winner and savers and the taxpayers are seen as the losers.
The video’s criticism of the Fed’s links to Goldman is also a protest against TARP, the Fed’s role in the de facto nationalization of AIG, the fall in interest income accruing to households, the revolving-door network whereby the regulators and the regulated play musical chairs with more than enough chairs, and so on. The American people care deeply about fairness, but the Fed is perceived to care more about the health of Wall Street than fairness. Instead of addressing the underlying issue of fairness and the efficiency of the bailouts, the Fed defenders focus on a narrow legal prohibition.
The video is popular and effective because it is not a detailed-footnoted-rigorous academic exercise. It humorously plays on what a substantial fraction of the audience already perceive to be true. It takes swipes at what many viewers see as an institution that is charged with promoting economic welfare yet they see it both detrimentally affecting their lives as well being arrogant and well insulated from accountability.
The Fed dismissed its critics while the housing bubble grew. It did so to its own detriment as well as to the detriment of the real economy and the financial sector. Those who defend of the Fed against the criticisms in this video may win every definitional battle, but they will lose the war for the hearts, minds and confidence of the American people. If the Fed and its supporters want to win the war, they must address the larger concerns:
1. Admit past mistakes (not because confession is good for the soul, but because the Fed can then assert it has learned from past mistakes and less likely to made mistakes in the future);
2. Explain fully the necessity of the financial interventions (For example, the majority of American believe that the AIG’s problems were limited to AIGFP and that AIG posed no systemic risk.);
3. Explain fully the reasoning behind the path chosen (TARP and interest rate subsidies) versus nationalization of failing financial institutions;
4. Explain the continued adherence to the economic and policy frameworks that failed to produce sustainable full employment and price stability and are seen by many as having contributed to financial instability and economic unsustainabilities which resulted in the financial crisis and the recession.
Maybe then the American people will respond better when the Fed says “trust me” in response to questions about a timely unwind of QE.