Paul Krugman was kind enough to link to me with respect to a Guardian article pointing to his criticism of the fiscal stance, and arguably more important, the political role that the Bank of England governor Mervyn King is taking. However, Krugman said I was in error in claiming he never criticized Greenspan for compromising Fed independence.
As an aside, I’m taking King’s side a bit more than I might otherwise. Yes, I agree fully with Krugman that austerity is a bad idea in the UK and pretty much anywhere still in a hangover after the global financial crisis. But there seems to be a lot of opportunism in the broadsides against King. He is the only central banker that has stood firm against the bad practices of the major dealer banks. And his dim view is reportedly widely shared among Bank of England staff. My sense (which UK readers confirm) is that the piling on seems unduly aggressive, and looks to be an effort to discredit King in order to weaken him (and as much as possible, the Bank) as a reformer.
I’m still going to quibble a bit. The NC remark in question about Krugman was: “And he’s said nothing about the “political” Greenspan and Bernanke.”
Now I’ll admit I stuck my neck out; “nothing” is a strong word, and Krugman has a large opus. The 2005 op-ed he cited as refutation gets to the matter of central bank independence only after dismembering Greenspan’s economics arguments at length:
They acted as if he were still playing his proper role, acting as a nonpartisan source of economic advice. After the hearing, rather than challenging Mr. Greenspan’s testimony, they tried to spin it in their favor.
But Mr. Greenspan is no longer entitled to such deference. By repeatedly shilling for whatever the Bush administration wants, he has betrayed the trust placed in Fed chairmen, and deserves to be treated as just another partisan hack.
It’s important to note that Greenspan acting in a political manner was well established by then; we pointed out it started in the Clinton era. But I will concede that Krugman did comment disapprovingly of Greenspan taking a political role, although it was a secondary line of attack.
Where we differ with Krugman on Bernanke is whether “raw partisan advocacy” is the only way a central banker can compromise his independence. We’ve argued at length, as has former central banker Willem Buiter, that the extensive Fed involvement in extra-budgetary commitments is at least as serious a violation of the Fed’s proper role. Buiter makes the case with considerable vigor and authority:
The Fed does not have a full indemnity from the US Treasury even for its outright purchases of private securities. It has no guarantee or indemnity for private credit risk assumed as a result of its repo operations and collateralised lending.
For the Fed’s potential $1 trillion exposure to private credit risk through the Term Asset-Backed Securities Loan Facility, for instance, the Treasury only guarantees $100 billion. They call it 10 times leverage. I call it the Fed being potentially in the hole for $900 billion. Similar credit risk exposures have been assumed by the Fed in the commercial paper market, in its purchases of Fannie and Freddie mortgages, in the rescue of AIG, and in a host of other quasi-fiscal rescue operations mounted by the Fed and by the Fed, the Federal Deposit Insurance Corporation, and the US Treasury jointly.
I consider this use of the Federal Reserve as an active (quasi-)fiscal player to be extremely dangerous and highly undesirable from the point of view of the health of the democratic system of government in the US.
There are two reasons for this. First, it undermines the independence of the Fed and turns it into an off-budget and off-balance sheet special purpose vehicle of the US Treasury. Second, it undermines the accountability of the Executive branch of the US Federal government for the use of public resources – taxpayers’ money.
As for the Fed’s independence (whatever independence remains), first, even if the central bank prices the private securities it purchases appropriately (that is, there is no ex ante implicit quasi-fiscal subsidy involved), it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.
As regards democratic accountability for the use of public funds, even if the central bank has sufficient capital to weather the capital losses it suffers on its holdings of private securities, the central bank should never put itself into the position of becoming an active quasi-fiscal player or a debt collector… The central bank can act as a fiscal agent for the government. It should not act as a fiscal principal, outside the normal accountability framework.
The Fed can deny and has denied information to the Congress and to the public that US government departments like the Treasury cannot withhold. The Fed has been stonewalling requests for information about the terms and conditions on which it makes its myriad facilities available to banks and other financial institutions. It even at first refused to reveal which counterparties of AIG had benefited from the rescue packages (now around $170 billion with more to come) granted this rogue investment bank masquerading as an insurance company. The toxic waste from Bear Stearns’ balance sheet has been hidden in some SPV in Delaware.
The opaqueness of the financial operations of the Fed in support of the financial sector (which are expanding in scale and scope at an unprecedented rate) and the lack of accountability for the use of taxpayers’ resources that it entails threaten democratic accountability. Even if it enhances financial stability, which I doubt, democratic legitimacy and accountability are damaged by it, and that is too high a price to pay.
Note that some of this information has been pried loose from the Fed, for example Maiden Lane I (Bear Stearns) exposures, but have been presented in such a manner as to be obfuscatory (it’s low level disaggregated data, with swaps reported separately from presumably related underlyings. It’s a given that Blackrock, Maiden Lane I’s asset manager, provides far more user friendly reports to the Fed).
And we are not the only commentator to see it this way. Ed Harrison wrote in “The creeping power grab by the executive branch and Federal Reserve“:
The Fed has been engaged in a policy of acting in concert with the Executive Branch in a non-arms length fashion since this crisis began. All of the liquidity programs and backstops the Fed has implemented are not just about liquidity, they are subsidies that lower the cost of capital and increase profits in the banking sector. As such, these subsidies are actually a part of America’s fiscal policy – stimulus, if you will. It is a clear no-no for the Federal Reserve to inject itself into fiscal matters. And to top it off, the Fed is refusing to be transparent about the process. Why would we make it the Systemic Risk Regulator?
Oh, and the head of the Philadelphia Fed was also not too keen about blurring the lines between fiscal and monetary policy:
The Federal Reserve should not be involved in financing toxic assets that date from the bubble era, Charles Plosser, president of the Philadelphia Fed, has told the Financial Times.
“I think it is a bridge too far,” said Mr Plosser, arguing that such proposed Fed loans would expose the US central bank to credit risk and tie up a sizable chunk of its balance sheet in long- term assets that would be hard to price and liquidate…..
“I have reservations about the Fed intervening in private credit markets as a matter of principle. I think it confuses monetary and fiscal policy,” Mr Plosser said.
We’ll concede we overstated our case about Krugman on Greenspan, but we beg to differ with his giving Bernanke a fee pass. The current Fed chairman’s better bedside manner should not obscure the fact that he has compromised central bank independence far more than Greenspan did or King has.