Alford: The Fed Tests The Thesis That Two Wrongs Don’t Make A Right, But Three Do

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.

In reaction to the OPEC-engineered oil price spikes of the 1970s, which economists would depict as external negative supply shocks to the US economy, the Fed pursued expansionary policy with an eye to insulating US income. The unintended consequences were the double-digit inflation of the late 1970s and then the anti-inflation fight and the painful, costly recession of the early 1980s. As a result of this episode, central banks increasingly pursued inflation-only targeting.

Since at least the early 1990s, the US has experienced a positive long-lived external positive supply shock. Globalization and a semi-fixed dollar exchange rate led to imported disinflationary pressures. Employment and capital utilization rates came under pressure as US manufactured goods were replaced by lower-cost alternatives in the US and world markets. The Fed uses so-called Taylor rules to evaluate where to set interest rates, and those lead it to focus on unemployment, inflation and inflationary expectations. It set interest rates policy as if the downward pressure on inflation and employment stemmed from declines in demand by US based economic agents and were not the result of increased external supply. To put it more simply, its implicit US-only focus meant it ignored how a rising level of cheap imports was keeping US prices lower than they would be otherwise.

This incomplete assessment in turn led it to set an overly expansive monetary policy and convince itself that all was well when imbalances were building up in the US and with our trade partners. The Fed succeeded in temporarily stabilizing inflation and US GDP (the Great Moderation). However, it failed to exercise its regulatory and supervisory responsibilities even as monetary policy encouraged the buildup of leverage and maturity mismatches. Of equal importance, monetary policy promoted growth via asset price inflation and debt-financed spending even as purchases of final goods and services by US based economic agents exceeded US potential output by as much as 6% and the trade deficit- to-GDP ratio exceeded levels associated with crises. In short, expansionary Fed policy (largely driven by the impact of globalization) contributed to financial instability, depressed private savings and encouraged the unsustainable trade deficit. Once again, unintended consequences of monetary policy were very costly.

The Fed repeated the policy mistake it made in response to the OPEC oil shocks of the 1970s. It tried to use tools of domestic counter-cyclical aggregate demand management to insulate US incomes and prices from an external supply shock. Only this time it was positive supply “shock” was structural i.e., globalization.
After almost two decades of “A strong dollar is in the US interest,” the Fed setting policy as if US prices and incomes were exclusively determined domestically and the trade deficit reaching 6% of GDP in 2005-6, US policymakers have finally started to wake up to the fact that US is not an economic island.

But what has the Fed learned? QE2 is another attempt to increase US GDP and employment by generating additional domestic demand via asset price increases and wealth effects, but the wealth effects are likely to be small and fleeting. (See Hussman here.) More to the point, the Fed has also apparently decided to use QE2 to de facto exceed its legal mandate and co-opt Dollar policy. Fed is apparently setting policy with an eye to reducing the value of the dollar relative to other currencies in order to promote income growth. In short, after decades of setting policy as if the dollar and the rest of the world did not matter, the Fed now wants to manipulate the value of the Dollar and alter the global financial landscape. In doing so, it risks both the consequences of a setting off a change cascade of competitive currency devaluations as well as importing inflation. It also reduces incentive to of the Executive and Legislative branches to act while at the same complicating what is their job.

The global response to this attempt to shift the cost of adjust on to other countries has been decidedly negative. After enjoying all the benefits of the “exorbitant privilege” associated with being the bank of issue of the world’s reserve currency, the Fed now seeks avoid the responsibilities that go along with being the issuer of the reserve currency. It is as if the Fed wants to prove that there is a “free lunch” after all.

What should the Fed have done in the 1970s, during the bubble years? What should it do going forward? Bernanke recently wrote in a Washington Post Op-Ed: “The Federal Reserve cannot solve all the economy’s problems on its own.” The Fed should have acted in a manner consistent with that observation in the 1970s and through the bubble years. It should act that way now.

The Fed is ill-equipped to deal with external supply shocks and imbalances. The Fed should not have tried to insulate the US from the global developments. It should have passed the ball to those responsible for external economic policy: Treasury, the White House and the Congress.

Would unemployment have been higher given globalization and in the absence of the Fed policy response? Yes, but not as high as it is now. Would the US have experienced asset price bubbles and a financial crisis? It is possible, but they would not have been as large or destructive. Would the Fed be faced with the need to employ unconventional monetary policy? It is very unlikely. If the Fed had not masked the affects of globalization on the US economy, the appropriate policy makers would have had more pressing incentives to address the external imbalances. Furthermore, the policymakers would have been addressing imbalances more manageable in size and without the complications of the financial crisis.

The Fed is ill-equipped to deal with external supply shocks as witness by the unintended consequences of polices pursued in the 1970s and then during the years prior the recent crisis. It should avoid policies that seek to offset or correct external developments.

The Fed should refocus its efforts on its regulatory responsibilities and on offsetting swings in domestic animal spirits that might adversely affect US economic performance. Fed policy should not be aimed changing the global economic landscape. Given history and the limitations of monetary policy, the Fed should stand aside and leave external economic policy to the appropriate elected officials.

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  1. Tao Jonesing

    “QE2 is another attempt to increase US GDP and employment by generating additional domestic demand via asset price increases and wealth effects . . .”

    No, it isn’t. QE2 has nothing to do with the Fed’s dual mandate because it is plain that the money will never find its way into the real economy, either because it will be “disappeared” to offset losses or paydown debt, or because it will be loaned to financial speculators (the only people still borrowing, something the Fed knew before it announced QE2).

    We need to stop listening to what the Fed and Bernanke say, and focus on what they actually do.

    These people aren’t stupid or misguided. They know that what they’re doing won’t accomplish the things they say they want to accomplish in public. They also know that what they’re doing will accomplish the things they actually want to accomplish but don’t talk about.

    Deflation is inevitable. The Fed is attempting to manage a soft landing for the banks at the expense of everybody else. All Bernanke is doing is herding people into making investment decisions based on inflation that ain’t gonna happen, and the banks are going to reap the rewards. The age of big asset bubbles is over. We’re going to have a series of mini-bubbles that ratchet us down to where the markets really need to be.

    1. Thomas Barton, JD

      I think your analysis is compelling. I thought QE2 served its purpose in pumping up the stock market valuations prior to its formal announcement and then would serve as a Shock Absorber to limit the short-selling potential against the top 19 banks here in the State. Do you have any thoughts on a recent ZeroHedge posting that said the Fed was using QE2 to specifically aid the vast derivatie positions of the top 5 US Banks ?

    2. TC

      I disagree. Deflation is not inevitable. Rather, global economic contraction forced by the inability of producers to pass along rising input costs is. This is the Fed’s objective, and Bernanke said so much in Jacksonville, FL late last week.

      The Fed is attacking what it calls “excess supply” with its hyperinflationary, QE policy. Of course, this is not referring to the excess supply of insolvent securities choking the global financial system. Rather, the Fed’s aim is directed toward commerce. Collapsing this sufficiently will bring to market increasing stores of physical assets for pennies on the dollar, and these will provide the backing for that mountain of soiled toilet paper Benito Bernanke is desperately trying to save.

      The Fed’s policy is fascism, pure and simple. (And yes, this needs shouting.)

      Picture the presently crippled job market even more so dysfunctional. Millions taking work for whatever meager wages will be paid. A virtual slavery to King Debt whose build up was accomplished by the greatest fraud (Ponzi scheme) in history — securitization — will become even more painfully obvious than is the case right now.

      QE is the means by which the debt trap built by Herr Greenspan is to be shut. In the process the most powerful government on the face of the planet is likewise to be made prostrate. Am I revealing anything not already plain to see? Is not the Congress filled with cowards who, apparently, wouldn’t know a fascist from a fudgesicle?

      Fascism! That picture of Hjalmar Schacht in Benito Bernanke’s office is no strange thing. Rather it is perfectly fitting to that un-American policy this man embraces.

      So, to summarize, there will be no deflation. Benito has made this clear. But slavery to an illegitimate debt that is made so by the manner in which every principle put forward in the U.S. Constitution’s Preamble is perfectly defiled? This is the QE agenda.

  2. i on the ball patriot

    “The unintended consequences”
    “it ignored how a rising level of cheap imports”
    “This incomplete assessment in turn led it to”
    “Once again, unintended consequences of monetary policy were very costly.”
    “The Fed repeated the policy mistake it made”
    “The Fed should refocus its efforts on its”

    Nothing to see here, just a handful of bumbling idiots who know nothing about intentional bubble blowing, fraudulent over leveraged derivative products, cronyism, corruption, oppression, exploitation, fucking the little guy up the ass, global herd thinning, etc., lets all move along now to the next CYA item, the Bush book tour …

    Deception is the strongest political force on the planet.

    1. Jason Rines

      Alford is correct and while your point is not untrue IOTBP, I construed it as insulting to the author and juvenile.

      Tao, the QE2 will have an impact in creating jobs. Just not in the USA and that is intentional. Forty years of mandraking to China.

      Ben Bernanke can hire innovators to use a scalpal, determine underutilize value rapidly and increase the labor participation rate.

      QE2 could be used as a reseeding mechanism at the local domestic level but if it is not, than the model of the Federal Reserve will prove once and for all its stated benefits of market stability are hogwash. That some of the PD’s now have living wills are proof positive that the current banking system sees itself in danger of being expelled from the country, perhaps the entire world itself. But evolving at this point is probably far less dangerous then abolishment.

      1. i on the ball patriot

        We wear the shoes that fit us.

        No balls! No brains. No freedom!

        Deception is the strongest political force on the planet.

        1. Jason Rines

          Language matters I On The Ball Patriot, it doesn’t mean an individual has no brains or balls. Using gentlemen-like language but still standing up to the greatest Fascist machine ever seen on earth takes huge balls.

          Alford’s message is not directed to you, it is directed at Kingmakers to make wise individual choices.

          1. i on the ball patriot

            Yes, language does matter Jason Rines.

            Using gentleman like language Jason Rines — giving civility and respect, very deflective civility and respect I might add, to those who give you lies, bullshit, and death, of an order of magnitude of that which you have yourself metered out — does not take huge balls, it is an act of cover your ass sniveling cowardice, and that cowardice is proportional to one’s understanding and position, as in; some pigs are more equal than others …

            “Amnesty: prosecute Bush for admitted waterboarding”


            Who the fuck made you Jason Rines, the hall monitor that can label me as juvenile and insulting. You want insulting … here, get insulted …


            We wear the shoes that fit us Jason Rines.

            No balls! No brains. No freedom!

            Deception is the strongest political force on the planet.

          2. Jason Rines

            I like your spunk but until you use YOUR REAL NAME and sign on the dotted line for freedom, you have no claim to call others cowards.

            I was not defending bankers, I was defending the fact that you needlessly felt the impulse to insult the author for addressing corrupt world leadership in the terms they understand. Some are seeking redemption. Shall we speak Spanish to them when they understand English?

            I am no hall monitor, I called you out fairly for attacking Alford and your embarrassed for a rare moment of impropriety so now it is time to deflect into what? If I agree or disagree with the acts of violence you linked for me to see? Or somehow that I must now use gutter language to make a powerful argument just because your now losing it? Or should I lash out at other Americans? Allow me to bring you back friend:

            The Declaration of Independence:
            1) Alter
            2) Abolish

            I think I will give alter a bit more time. And I can calmly, yet coldly continue preparing for the dangers of this period and how to address them.

          3. i on the ball patriot

            And now, Jason Rines, the hall monitor who claims to be not the hall monitor, requires YOUR REAL NAME or you have no claim to express opinions of others viewpoints. Sounds like that specious, “You can’t complain if you don’t vote.” line. Anyone that thinks their is real anonymity on the net is a fool.

            You WERE defending, and still are defending, bankers when you defend such limp dick, deflective, hat in hand, apologist, cover your ass language and now tell me that it is language in the terms that corrupt world leadership understands. Gag me with a fucking spoon. Sorry Jason, but corrupt world leadership loves that limp dick drivel. If you listen very carefully you WILL NOT hear them trembling.

            Language is a deception Jason, an externalization and a tool of dominance made to get needs met. Your implying that my language is gutter language is an attempt to demonize me and lessen my viewpoint under the guise of your being a righteous champion of civility and respect.

            Yes, Jason Rines hall monitor, he knows what is gutter language, what is acceptable language, and he can point out those who do not conform and need to be upbraided. So keep working to keep it all squeaky clean Jason, and here again is the real gutter language … a language that the big, more equal pigs (all), at the FED extract rent from …


            Deception is the strongest political force on the planet.

  3. Paul Repstock

    Well..There you have it in a nut shell. Why do we place our trust in omnipotent governments, then allow the creation of bodies which are not answerable or accountable, and expect that these forces will not go astray or be co opted by negative forces? We are such easy marks and we always buy into the story of our own falibility while overlooking that our appointies are also only human.

  4. LJR

    QE2 flattens the yield curve and forces the banks to seek yield elsewhere. Other economies will institute capital controls to limit inflow of hot dollars. So where does Goldman put all this new money they’ve gotten? My guess is they’ll create another commodity bubble and then short it at the top. The Fed’s wet dream that banks will lend to business and thereby stimulate the economy will end quickly enough when the Fed wakes up to the reality that lending is dead because borrowing is dead. You can’t defibrillate a dead horse.

    Perhaps it will dawn on these quasi-intellectual quacks that what happened from 2003-2007 was not normal and we can’t expect to return to that level of “prosperity.” There is no asset class comparable to housing for creating exuberant animal spirits in the lumpenvolk. The banksters monetized and sucked dry the American Dream. It’s not coming back – we sold it to sCalpers and Saudi Arabia as pooled securitizations.

    It sure looks like the US is making the same mistakes the Japanese made. Apparently, just as the banks owned the Japanese government, our banks own the federal government and that’s exactly why the “remedies” bear such similarities.

  5. Jim in MN

    I admire the author’s experience and think most of the points are correct. However, it still sidesteps the essential issue of corruption. None of the ‘misplaced analysis’ is as important as the AIG par payola, the No Bond Haircuts policy, and the consequent economic disaster. Not allowing the losses to accrue to those who bet is bringing the system down: economic, political and social ‘RED ALERT’ sirens are screaming and we will, sadly, crash and burn because of corruption.

    High crime trumps policy error as it delegitimizes and renders the system moot.

  6. sandorgb

    It’s amazing that after a series of outright disastrous policies and their predictable results, people take BB’s comments or the “Fed mandate” at face value. The Fed mandate is for asset-stripping. The rest is a sideshow. How can otherwise reasonable people observe the present economy and think that the Fed is credible in any way or deserves to be considered as anything other than an enemy of freedom and prosperity?

    This is the Wizard of Oz, pure and simple. Bernanke is the fortune-telling charlatan who came and went in a hot-air balloon. Helicopters, balloons, asset bubbles, you get the idea. Ironically, the Wizard of Oz is a parable for the silver/gold standard debate at the turn of the last century. It really is about the bankers and raising the curtain on their fraud.

  7. Paul Repstock

    A repost to get comment for any who are not already sick of my pontifications..:)

    The only way for Americans to escape the stiffling ‘Yoke’ of the Fed and the Corporate TBTF banks is to say “We don’t want your Marbles!”. The leverage and the implied threat here is always, that the people will loose everything if the banks are not continuously supported. I have news for you. The system is a fraud. If you would have nothing if the banks failed, then you don’t have anything now. The only people with anything to loose are the ones who own and control the banks.

    Do not imagine that the rest of the World’s governments are blind to this. However, they are using the deception for their own ends.

    What do you think would happen if the United States of America pushed the China too far and misjudged their importance to China… Then the Chinese government said as above…”We don’t want your marbles”; An subsequently piled every US Dollar, and every T Bill, Bond, and other US financial obligation, in the middle of Tianamen Square. Then they light a bonfire (forgive the debt).

    The Debt structure is being used to justify everything including itself. If the debt structure is repudiated on a large enough scale the whole government house of cards collapses.

    Why do you think it is illegal to burn or otherwise destroy a dollar bill which you have earned and should therefore be yours?

    1. sandorgb

      If you the raise the standard of living just high enough to provide an illusion of well-being (bread and circuses), workers will tend to prefer de facto indenture servitude to the alternative uncertainty associated with revolution. Especially if you include a lottery effect which gives everyone the dream they too can join the elite.

      Things need to deteriorate considerably before you have full scale repudiation. The system has an inertia of its own, especially because people with children need to feed their families. They are de facto hostages without their own farmland.

      1. Paul Repstock

        Revolution is not a resonable solution. It is just a fancy, and very costly, way of saying ‘regime change’. It does not change the structure. To change the stucture one must change the value system.

    2. tar, etc.

      Heh, heh. Speaking of repudiation, how about the US citizens do a deal with the Chinese that cuts out the outsourcing corporations and the Fed. We swap factory assets for debt. They get hard assets, and we agree that we will not fight for those who have shown no loyalty to us. Wow, that’s coloring outside the lines. However, having now lived my whole working life under the tender mercies of the not-Federal Reserve and the multinational corporations, I’m a little fed up, so to speak.

  8. Jackrabbit

    After all that the Fed (and the Obama administration)has done to support the banks, It amazes me that people (especially the MSM) take the Fed at their word – that the primary goal of QE2 is to reduce unemployment.

    The Fed itself has said that they are not sure to what extend QE2 will help the real economy (but they feel that they have to try). What we DO know is that it will help TBTF banks, which are still hurting badly:
    * Meredith Witney expects (before QE2) that they will lay off tens of thousands in the coming months
    * they have over $400b of seconds and thirds that are mostly worthless, and
    * they have the ongoing fallout from the foreclosure mess and demands for put-backs to contend with.

    Both critics and supporters of QE2 are talking past each other. The Fed can’t say that QE2 will help the banks, so they focus on their “mandate” for unemployment. This leaves some thinking that the Fed is riding to the rescue so fiscal stimulus is unnecessary (and the Bush tax cuts can be extended). Critics complain that QE2’s wealth effects will be largely ineffective so they focus on the effects on the dollar. That leads to the false believe that the Fed is usurping Tsy (OMG!). In fact, Geithner and Bernanke are on the same page: save the banks. Thus it came as no surprise that Geithner talked down QE2’s effect on the dollar and Obama made statements defending QE2.

    It is unfortunate, however the the Fed has been put into this position – and that Bernanke has played along (some would say its an impossible position and that he is making lemonade). The Fed is unlikely to be able to save the economy on its own and will almost certainly be criticized for either going too far or being too timid in its QE2 program. History make also question the wisdom of the Fed’s promoting what appears to be a ponzi-like scheme where the Fed hopes that “greater fool” investors will respond to the Fed’s manipulations (especially coming so soon after the shennanigans that propelled the credit bubble).

  9. MakingtheDrop

    Jim in MN, you pegged a basic tenant here, “Not allowing the losses to accrue to those who bet in bringing the system(s) down…” It may not really be a sad thing afterall. Systems, like organisms, as they evolve will implode upon themselves or metamorph into something beyond expectation. I’m hoping for the metamorphosis…

  10. Paul Tioxon

    This analysis lays out an institution charged with primarily domestic over sight for the US economy and the policies which can be initiated and controlled domestically, The Fed and those charged with the international components of foreign initiated policies which have domestic economic consequences, Treasury, WH and Congress. This is somewhat analogous to the mission of national security being divided between domestic defense by the FBI and international defense by the NSA/CIA.

    The Fed is being accused of mission creep or simply taking the entire burden, domestic and foreign, by default from a weakened or deliberately disinterested Treasury/WH/Congress.

    It should come as no surprise that a permanent government of bureaucrats and powerful interests won’t let nitwit republicans with bible cult leaders, with anti-science apocalypse irrationality any where near the economic levers of power. Spending decades passing no legislation what so ever other than prayer rituals to resurrect Terry Schiavo should be a relief, but by design or default, the Fed seems to be in the position to announce and execute policy. In other words, they have this power because the people with power want them to have it. The Machiavellian stage production of astro-turf tea parties and the like prevent governing from happening. And that is just as good as drowning the baby of government social spending and economic policy making in its bath water.

    1. Jackrabbit

      And yet, only weeks before the mid-terms (!!!), both houses of Congress passed, at the behest of the financial industry, what they certainly knew to be unpopular legislation: HR 3808, a ham-fisted attempt at making the fraudclosure crisis go away.

      “Powerful Interests” don’t want either party near the levers of financial power, but It seems that they don’t have much problem manipulating either party to get what they want.

    2. JTFaraday

      And I’m sure they could come up with a string of epithets that details why they don’t want the D-Party base anywhere near the levers of power either.

      I’m still recovering from a bad case of hives I’ve had since the 2008 primary myself.

  11. Liminal Hack

    “Fed policy should not be aimed changing the global economic landscape.”

    Obviously I don’t agree. Given that the PBOC, the BOJ and a host of global corporations are all doing their damndest to change the global economic landscape all the time it would be unwise for the monetary or fiscal institutions of any nation to let its guard down lest those wolves sink their teeth into the soft underbelly.

    The simple fact is that your political system is so totally gridlocked and paralysed and polarised that the Federal Reserve is the only body left in America that is capable of making any meaningful policiy decisions at all, whether they be right or wrong (or is that left or wrong?). And as usual the body that takes the decisions takes all the flak.

    And of course this makes perfect sense when you consider that really, your vote matters not one jot, but your spending (or withholding of the same), really, really matters. You can vote effectively with dollar bills, just like the lobbyists.

    Not surprising then that the Fed is calling the shots while washington puts on a nice pantomime ‘he’s behind you, oh no he isn’t, oh yes he is, who’s got my gold boys and girls’, with all the trappings of pantomime baddies and the self concious hyperbole that go with them.

    When I say ‘you’ I only do so because I’m not american, but its the same story in blighty, I’m sorry to say, with the possible exception that our politics are not quite as polarised. Not that that’s an advantage, because this only increases the liklihood of someone doing something really stupid.

    1. TC

      Although in principle I agree that, a seemingly more effective vote is with one’s wallet, the most powerful vote remains with one’s representatives in Congress (the House and Senate). Each House member represents approximately 350,000 people. Of these, only a handful are politically active. So, organize a few hundred people in your Congressional district and bombard your representative in the House with your message every day of the week and twice on Sunday — constantly — and you exercise your power to vote commensurately, and probably to much greater effect than would be possible with your wallet.

  12. steelhead23

    There is a premise in this discussion I very much like – that engineering a growing money supply and increasing access to credit into the U.S. with no real GDP growth (asset value growth and financial business growth does not count) softened the blow of the loss of manufacturing due to globalization and that softening allowed politicos to ignore the problem. Bravo. Freakin’ bravo. The Fed enabled the U.S. Government to avoid the negative consequences of its trade policies. Good stuff, my man, good stuff. The only value a private Fed could provide to the U.S. People would be to ensure that the pain of bad policy was quickly realized and corrective steps taken. Without this brake, there is absolutely no value in an independent Fed.

  13. Jim Haygood

    What the Fed is doing is economic central planning — attempting to day-trade the economy by manipulating interest rates.

    It doesn’t work any better for the Fed than it worked for the Soviets.

    Central planning of interest rates does not add value. Give it up already.

  14. Jim Haygood

    A rather amazing fact emerges if you take the $20.67 price of gold in 1926 (the year the Ibbotson data start) and the $1,400 price of gold today, 84 years later.

    Over the past 84 years gold has delivered a 5.15% annually compounded return.

    That’s nearly as high as the 5.50% compounded annual return delivered by government bonds over the same period.

    Gold’s ability to nearly keep pace with long bonds (while leaving T-bills in the dust), despite not paying any yield, is a rather stunning rebuke to the Federal Reserve’s dollar devaluationists.

    Gold is making a monkey out of Bernanke.

    1. Liminal Hack

      “A rather amazing fact emerges if you take the $20.67 price of gold in 1926 (the year the Ibbotson data start) and the $1,400 price of gold today, 84 years later.
      Over the past 84 years gold has delivered a 5.15% annually compounded return.
      That’s nearly as high as the 5.50% compounded annual return delivered by government bonds over the same period.
      Gold’s ability to nearly keep pace with long bonds (while leaving T-bills in the dust), despite not paying any yield, is a rather stunning rebuke to the Federal Reserve’s dollar devaluationists. Gold is making a monkey out of Bernanke.”

      That is exactly the process I have described by which the abomination of nominal risk free securities that pay interest (golden geese) are eliminated.

      That they are being eliminated by seeing their price rise until they are in line with gold (so then we have two nominal risk free items at the same price, with the bond price slightly higher to reflect carrying costs of gold)) may seem unfair but thats how the world works.

      Land bubbled for the same reason.

  15. ds

    What this piece really seems to imply is that the Fed has a limited arsenal. It cannot prevent nations from running low pegs, it cannot negotiate trade agreements, it cannot conduct fiscal policy, and it cannot directly regulate the financial industry in the way the fdic, sec and cftc can. Its principal source of influence is interest rate policy which is a very blunt instrument.

    The alternative to the Fed policy which the author criticizes is, and would have been higher interest rates. Higher rates would only have prevented the bubble in the sense that it would have caused the Depression in 2001 instead of 2008.

    The criticism of the Fed in my mind was its self-aggrandizement during the supposed “Great Moderation” which basically told all other arms of government to back off and let the Fed run the show. This was a disastrous mistake. But that certainly does not mean that pushing rates higher would be a good thing — unless, of course, you feel that an economic and social collapse would lead to meaningful political change.

  16. scraping_by

    “…its implicit US-only focus meant it ignored how a rising level of cheap imports was keeping US prices lower than they would be otherwise. ”

    But also remember, that lower immediate price was the result of foreign government policy. The export subsidies, financial and economic, covert and overt, were precisely to drive American manufactury into the ground and to pull dollars to their own economies. It wasn’t wage differential, it was economic warfare.

    While US Government trade policy should have taken care of this, the ideology of Globalization took hold in a bunch of politicians who found it paid quite well. The rest was just details.

    I am no defender of the Fed as constituted. I think if the US needs a central bank, it should be a government entity, the way any sane government has it. But it’s not their place to look after the world economy, not matter what a bunch of idealists said a couple of generations ago. Since the foreign types took no care of our economy then, we have little enough reason for us to fret about theirs now.

  17. rp

    Completely disagree. Fed policy, which has been outrageously bad for America, gave the developing world and particularly Asia a massive free lunch. And in being so generous, the United States has had far more influence on the direction of Asia’s development than anyone alive could admit. This may have to stop, but from a historical perspective, at a critical time and at great expense to itself, America lead 6 billion people in the right direction. May we not be so foolish as to throw that away.

  18. Brick

    Take US GDP, Unemployment, Wages, Output Gap feed it into a FED economic model to get a FED policy decision.

    Who could have known that external economics would give a negative supply shock that derailed FED policy in the 1970’s.

    Take US GDP, Unemployment, Wages, Output Gap feed it into a FED economic model to get a FED policy decision.

    Who could have known that external globalisation would give a positive supply shock that derailed FED policy during the early 2000’s.

    Take US GDP, Unemployment, Wages, Output Gap feed it into a FED economic model to get a FED policy decision of starting QEII.

    Who could have known that external inflation, a supply shock, retaliatory capital controls would derail FED policy.
    Richard is right that the FED because of the size of the US economy needs to model not just the US economy but the effects on the global economy. There are feedbacks and transmission mechanisms like carry trades which need to be modelled. Unlike Richard, I think they are becoming aware but are making the same mistake again.

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