Calling on Yellen: Time for a Modest, Dull Fed

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Most of the news accounts of Obama’s nomination of Janet Yellen as the next Federal Reserve Chairman focused either on what type of monetary stance she was likely to take or on biographical details.

But some writers have used the upcoming changing of the guard at the Fed to look at the bigger question of the Fed’s role, particularly now that it has continues to intervene in financial markets to an unprecedented degree, a full four years after the worst of the financial crisis had passed.

Two particularly commentaries, one from a progressive stance, the other a much more conservative position, call for a more modest Fed, one more focused on the nuts and bolts of banking regulation and less bedazzled by the power of monetary policy.

The desire for a different Fed than we’ve had in recent years reflect deep, underlying discomfort with the lack of accountability of the central bank. It has fetishized “independence.” Central bank defenders contend that in a democracy, the monetary authority might capitulate to pressure to stimulate the economy by setting rates too low. But the problem with that argument is that in the US, before the Fed was created, our central banking functions were handled for over 70 years by the Treasury, and banking interests look to have dominated over popular ones then as now (deflationary policies in the late 19th century followed by adoption of the gold standard in 1900).

And the Fed in the Greenspan and Bernanke era has wanted to have its cake and eat it too, invoking its independence to beat back calls for more supervision, yet meddling in policy debates in a way that would have been unthinkable in the era of William McChesney Martin. Consider a few examples: Greenspan’s loud and active support of deregulation, his approval of the Bush plan to privatize Social Security, as well as advocating cuts in Social Security and Medicare, his urging mortgage borrowers to use adjustable-rate mortgages. Bernanke was arguing for deficit reduction in 2011 (again, not the place of an independent Fed) while still engaged in QE.

Dan Kervick, who most readers know well from his writing at New Economic Perspectives on MMT and economic policy, wants a Fed that will stick to bank supervision and take a much less interventionist approach to monetary policy:

We need to end the barmy “maestro” system that has transformed Fed Chairs into rock stars, and turned every inadvertent nose-scratching by the Fed chief into a Page One story feeding hyper-reflexive and erratic market responses to real or imagined Fed signals. The maestro system, with its cult of superstitious fawning and slack-jawed wonderment at the Banker-In-Chief, has veered into extreme depths of perversity lately, as too-clever-by-half market practitioners attempt to outthink themselves at every turn, neglecting fundamentals and clinging to dotty theories about quantitative easing that turn good news into bad news and bad news into good news. The markets sometimes seem to have become nothing but free-floating postmodern casinos driven by arbitrary assignments of importance to Fed policy statements – and that’s a very dangerous thing for our economy..

I sincerely hope that five years from now hardly anyone pays attention to the news from the Fed, and that we hear little from our central bank other than some occasional inside page stories along the lines of “Banks Grumble about Tightening of Lending Rules”, “Fed Agrees with FDIC and OCC on Capital Rules Adjustments”….

The Fed is a bank, and serves as the organizing hub of our centralized banking system….The Fed is also charged with supplying an elastic currency to the US economy. In carrying out this function, it broadly accommodates the expansion or contraction of money and credit in our economy, an endogenous process that is driven primarily by economic factors and government policies external to the banking system, and that the Fed helps stabilize, but no means directs or controls….

Somewhere along the ways and byways of economic theory, an unromantic grasp of the sober institutional reality just described was transformed into fantastical monetarist-inflected theories portraying the central bank as the omnipotent controller of the money supply, the guarantor of full employment and the driver of aggregate demand. A credulous tilt toward these extreme theories was even written into our laws during a period when monetarism was in the first flush of enthusiastic ascendancy, and a whole generation of economists and pundits has since been raised on them, and taught to look to the central bank to steer and power our economies. There is now a rather substantial cottage industry of influential economic pundits and policy economists who are personally and intellectually invested in central bank-oriented monetarism, and who have placed career bets on its continued thriving. So it may be hard to break the hold of these outworn and frequently failed theories on the public imagination.

Direction of macroeconomic policy in a democracy belongs with the political branches of government, not the central bank. The Fed should be a pliant accommodator of government policy, applying an unobtrusive stabilizing rudder as the ship of government pushes onward in whatever direction the people choose to sail it. The persistent magnification of central bank importance has helped lead to a generation of Congressional and Presidential buck-passing, and is in part responsible for the grossly inadequate and immoral response of government policy-makers to the crisis of 2008.

Amar Bhidé, a professor at Tufts, manages to annoy the right and left. He invokes the Hayekian preference for decentralization to argue for bank regulation, albeit of a very different type than we’ve seen of late, which has increased concentration in the banking system. Bhidé prefers smaller institutions that aren’t hostage to simple-minded rules, like using FICO as a primary tool for evaluating mortgage borrowers, but can also use local market knowledge to make lending decisions. That’s similar to the stance of Andrew Haldane, executive director of financial stability of the Bank of England, who has, among other things, looked at biological systems to see which are more robust. Needless to say, ones with a dominant species aren’t very stable.

As Bhidé writes in Project Syndicate:

America’s system of government imposes particularly strict constraints on officials’ actions, reflecting a deep-rooted skepticism of philosopher-kings….

Today, enormous power is concentrated in the hands of the 12-member Federal Open Market Committee, which sets interest rates and regulates the money supply behind closed doors – decisions that are not subject to review or challenge. Retirees can sue if their homes are seized for urban renewal, but not if the Fed’s financial suppression deprives them of a return on their savings.

The Fed’s seemingly unchecked authority, like the National Security Agency’s warrantless surveillance, undermines ordinary Americans’ faith in their government…A more decentralized monetary authority would align better with America’s democratic traditions and economic reality.

As it happens, governments directly provide only a thin “base” layer of money; most money is created by banks extending credit. Such a “loan-by-loan” process usually allocates money and credit effectively; however, it can over-lend, stoking inflation and even triggering economic collapse.

But centralized, one-size-fits-all monetary policies cannot counteract booms or busts reliably, and often have unintended consequences. For example, while raising interest rates may help to curb inflation and possibly even avert a credit bubble, doing so curtails both sound and unsound lending alike.

A better approach would be to regulate individual banks, branches, and even loans, while limiting the Fed’s interventions to those that serve its original purpose of ensuring an adequate monetary base and acting as lender of last resort during panics, like the 2008 financial crisis.

A return to monetary decentralization would require radical policy changes, including the implementation of 1930’s-style laws enabling regulators to monitor banks, ensure that deposit insurance is credible and comprehensive, and halt off-balance-sheet financial activities…

Furthermore, Congress would have to relieve the Fed of unrealistic mandates for ensuring low unemployment and controlling inflation. While the Fed should be responsible for forestalling the monetary instability that can trigger intolerable inflation or mass unemployment, its policies cannot account for the many cross-currents that buffet prices and jobs. In the rapids, it is best to concentrate on keeping the canoe from capsizing, rather than worrying about maintaining a straight course…Amid heated debates over whether monetary policy is too tight or too loose, a more grounded approach based on the “do no harm” principle has received little attention.

Sadly, it’s in the nature of institutions to accept mission creep, sometimes because the incumbents like wielding more power, but at least as often to take up a duty that seems related to its mission, even it results in overreach or conflicting objectives. While the Audit the Fed push in Congress did lead to some modest increases in the central bank’s transparency, the leadership of the Fed was unwilling to entertain discussion of whether its role was suitable and whether it had adequate governance mechanisms. Unfortunately, I don’t see Yellen as the sort to raise such fundamental questions, let alone push for a markedly different role for the central bank. But it would sure be nice to be surprised.

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  1. s spade

    I think you are glossing over the real purpose of the Fed: to liberate the giant banks from the downside consequences arising out of the manic speculation that enables executive looting. The Fed, after all, was a Rothschild (Morgan) project from inception. To envision any public purpose for it these days is textbook fantasy. The kind of Fed you are hoping for presupposes a breakup of large banks and the restoration of Glass Steagall prohibitions. Single unit banking would be a good idea too, but don’t expect a captive Congress to deliver it.

    Bernanke was just ‘Greenspan Light’, and those who expect Yellen to become anything but ‘Bernanke Light’ are simply dreaming. Watch what she does and not what she says.

    1. Yves Smith Post author

      There is pretty widespread misunderstanding as to the impetus for the creation of the Fed. Even though most accounts of the panic of 1907 credit JP Morgan with halting it, that’s not true. Because it’s late, I don’t have time to dig up the details, but Congress was stuck with what was a huge bill at the time, IIRC $23 million. So the Fed was seen as a way to lessen the frequency and cost of panics, since even the titans of finance of the day couldn’t do the cleanups unassisted.

      And you also forget that the frequency of panics in the early years of the Fed was much lower than in the post-Civil War era up to the Great Depression, and that resulted not from speculation in the banking system, but in the stock market (it was super levered speculation, admittedly). That did blow back to the banking system because the mortgages of the day were five year balloons, and so many banks failed that depositors were wiped out, so there were fewer banks around to roll over the loans and many homeowners wound up unemployed and/or with their savings wiped out, so no sensible bank left standing would lend to them.

      Similarly, we had a 50 year period from 1933 till the S&L crisis which was again free of bank panics.

      So the idea that the Fed was created as some sort of conspiracy to let banks go nuts and party is not consistent with history prior to the era when bank deregulation became fashionable.

      1. beene

        It took from TR to FDR to set controls on banking and corporations. Without banking’s debt created money speculation would not have been as likely before or after.

        With the Fed we now have frequent bloom and bust cycles in banking and the market with the nation’s taxpayers picking up the tab.

        The country’s debt burden is a result of changes recommended by the Fed under Carter which permitted all the deregulation under Reagan.

        1. Yves Smith Post author

          Agreed re the current Fed. We’ve had the Greenspan and Bernanke put. I find it hard to believe we won’t have the Yellen put.

          I’m just saying the Fed has not always been in the business of supporting casinos.

        2. s spade

          No doubt you guys believe the boom and crash of the Twenties was just a case of Fed ‘mismanagement’. I disagree. The ideas you are retailing are textbook history. Everything happens for a reason and identifying the beneficiaries generally explains why things happen when institutions are key participants. All the problems of banking panics could have been solved by government money, just as Lincoln financed the Civil War without borrowing. They shot Lincoln and Garfield too and the creditor class was the only beneficiaries. A coincidence? McKinley takes a bullet and Morgan’s man TR climbs into the saddle. Another coincidence? TR runs a hopeless third party race in 1912 and Taft is run out in favor of Wilson, who brings in the Fed and throws America into WWI when the Morgan loans were about to go balls up.

          I suppose those bankers are not only rich but lucky too!

      2. beene

        I should have included in my last post we have not had a positive trade balance since 1976 as a result of Fed recommendations.

      3. NotTimothyGeithner

        Also the architect of the Federal Reserve and Glass-Steagall was a small town newspaperman who became a Senator from his op-eds being reprinted around Virginia; although, isn’t the perfect person to carry out the plot of international bankers?!?!?!

        More from the realm of bizarre but true; Jerry Falwell is buried in Carter Glass’s old front yard.

  2. Jim Haygood

    Congress would have to relieve the Fed of unrealistic mandates for ensuring low unemployment and controlling inflation. — Amar Bhidé

    Giving the central bank an employment mandate is surely mistaken. Manipulating monetary parameters to influence employment can’t possibly add any value.

    Inflation was never an issue until after the Federal Reserve was created. The U.S. price level was effectively flat from 1790 to 1930. Then it mushroomed by nearly 20 times, as gold went from the Fed’s principal asset to a tiny portion of the total. Gold’s transition to a minority share of Fed assets occurred during WW II, and not coincidentally, the wartime inflation of the price level just kept on going in peacetime too.

    Before the creation of the Fed, overnight interest rates went UP during panics, promptly taking out firms that couldn’t secure financing. Under the Fed’s perverse, unnatural regime, short rates are slashed to zero during panics to keep zombies like B of A and Citi (in 2008) alive. This is malinvestment writ large: institutionalized value subtraction.

    Abolish the freaking Fed before it turns a hundred years old. Because the U.S. will be a shambolic, fractured and violent Third World regime before the Fed ever turns two hundred.

  3. Chris Rogers

    With Yellen’s nomination, Obama now has three posts to fill on the Board of Governor’s – rumours exist that Tarullo may also exit early.

    From my own perspective on the regulatory/supervisory front, I’d like to see Thomas Hoenig as the new vice-chair.

    From a monetary policy/macroeconomic perspective, given Yellen’s concerns over unemployment, any talk of tapering is just that, talk. Indeed, and as has been debated in Asia by no less a person than Yellen herself, we have basically reached the limits of monetary policy with ZIRP and QE, as such, she does not have much room to manoeuvre moving forward – its not her fault, she’s been handed a poor deck of cards, but at the end of the day, only US fiscal policy can solve the present crisis, and the elite don’t want this – see debt ceiling standoff, or more like the prelude to the “grand Betrayal.”

    I’m with Dan on the supervisory front, a boring Fed will be positive and hopefully Yellen can encourage Obama to nominate someone like Bair or Hoenig for the Vice Chair – I doubt this will happen, but would sleep easier at night if it were to happen.

    1. curlydan

      I’d hope for supervision as well, but we all know that supervision cuts into profits, and we can’t have that.

      As for Hoenig and Bair, I think it’s unlikely either would get a sniff. Hoenig is too controversial, and Bair is probably not liked by Wall St.

      1. craazyboy

        I didn’t like how the choices got narrowed to two, right off the bat. When they did the Bernanke, I think there were at least 5 names kicked around. But B was seeded for the win, since he was Bush’s econ advisor, then moved to be Greenspan’s understudy at the Fed.

        If Obama is going to pick from current Fed members, there are at least 2-3 members that have at least talked up stronger bank oversight, and less aggressive reliance on monetary policy as the cure all for everything.

        1. NotTimothyGeithner

          We are dealing with Obama, and his Administration is a very small and very tight clique. When they didn’t have someone, they just went to the next most senior person in line for that job (Gates, Bernanke, Geithner, Holder).

          Much of it is born out of paranoia and narcissism, but then again economics is a self-selective field like so many others. There are more viable Republican candidates because liberals tend not to waste their time learning right wing propaganda to counter Marxism which is what American economics largely is.

    1. Yves Smith Post author

      We were not keen about Yellen. We just said she was better than Summers.

      Anyone we’d be keen about would not have a snowball’s chance in hell of getting nominated, at least with Obama as president.

  4. Peter Everts

    Actually, it’s time to disband the Fed. Allowing private banks to print our money and hold us hostage is criminal. Jefferson warned, we need to heed his wise advice. BBQ a banker.

  5. MikeNY

    Great post, and Kervick is absoutely right about the Fed’s complicity in, its enablement of, Congress’s dereliction of duty wrt the economy.

    Alas, Yellen was sounding every bit the Great Central Planner in yesterday’s presser.

    1. Dan Kervick

      Thanks. An activist Fed is now seen by many as a center-left stance. But shifting macroeconomic policy-making from the political branches to the central bank is one of several tendencies that fed into neoliberalism. The louder people call for the Fed to take charge of the employment situation and demand management, the more I ask why it is that they are so eager to keep the political branches out of the picture. Proving that unelected central bankers can manage the economy by twiddling monetary policy knobs is part of the neoliberal strategy for preventing a return to activist government. Despite the current rise of far rightists in Congress, when Congress was a more active player in the US economy we had a more equal, prosperous and financially stable society. Maybe all those earmarks and “pork barrels” weren’t such a bad thing after all? People used to send people to Congress to fight for a piece of the federal spending pie, and the net effect was that we all had more pie and plutocrats had less money.

      1. NotTimothyGeithner

        I think the demand for more Federal Reserve Action is just about shifting responsibility from either Democrat elected or their well wishers to the ivory tower decision makers by harping on the dual mandate while not noting the Federal Reserve lacks the mechanisms to fulfill the employment mandate at this juncture.

        The complicity by the liberal standard bearers in creating the current situation not just the antics of the last few weeks is just galling. Rachel Maddow-types (maybe not her on this issue but she is part of the problem) spent their programs defending the stimulus as the source of all that is good instead of hammering the President for making it too small and shifting the benefits to the wealthy through tax cuts and kinds of projects funded.

        At this point, the Democrats have claimed victory on the economy; while, economic concerns were overwhelmingly the number one issue before the recent antics by the GOP and during the artificial Syrian crisis. Instead of holding themselves and their friends accountable for the current state of affairs, they are declaring economic victory and blaming the same economy on the Fed.

        Especially for the underling class of the elite, any positive economic changes would undermine their personal economic dreams. People in the D.C. area are up to their eyes in debt. Shifting government spending from Washington metro to Hoboken, Detroit, Tuscaloosa, etc. would crash home prices, the primary personal asset of the bulk of the underling elite in the D.C. area. Keeping up with the Joneses is expensive, and many people are looking to cash out or sell their house in a hot market. The cash poor rich would have a problem too, and none of them want to face this reality which might occur if there was good policy across the board.

        1. Dan Kervick

          Especially for the underling class of the elite, any positive economic changes would undermine their personal economic dreams.

          Yes, I think this is a really important part of it. Class issues matter.

  6. Yancey Ward

    Too little, too late. The Fed will continue on this path until it falls. Then something else will take its place.

  7. Alejandro

    Not much solace for the sacrificial lambs of the jobless “recovery” nor the outcasts of the new “normal”.

  8. Paul Tioxon

    My daily daily monitoring of the news on the nbcs, shows the watchword, repeated throughout discussion after discussion was: CONTINUITY! When market types and putative commentators on the market were asked to talk about Yellen, there was approval, praise of her womanhood, supported by a world class resume, and more continuity relief. The most important thing about Yellen seems to be that she is one of the club and more of the same.

    Then, drama was insinuated into the reportage by wondering aloud, in breathless E-Entertainment style!!! how does it play out with her knowing she was not the President’s First Choice, but only there because the numero uno gave up and left the competition for king of the fed? Nobody was following that line, it all came back to market calming and approval of the decision signalling: CONTINUITY.

  9. fresno dan

    The Fed, from the perspective of my adult life, is an organization that seems incredibly inconsistent.
    Despite republican Fed chairs in the last 30 years, and the professed, but never followed philosophy of the free market, it sets interest rates at will. It bails out incompetent firms (LTCM). It can massively intervene in markets. It espouses non interference in markets by government, but de facto places a put on the stock market. It ceaselessly advocates that bank management can’t be held accountable for their incompetence and/or criminality (because that would be government interference – it says this with a straight face as it buys 85 billion of bonds per MONTH).
    That can’t see bubbles right before their eyes. There projections are amazingly and consistently wrong.
    And yet, they are held in high esteem.
    Other than 10th century Popes, have their ever been positions where the actions of the leaders have been more diametrically opposed to their professed philosophy of governance???

    Of course, I may be too harsh. I remember when Greenspan was the “maestro” – which just goes to show everybody loves a party, and it was a very long party.

    Maybe a more nuanced view is that the Fed alone wasn’t responsible for the party, and isn’t primarily responsible for the crash. And maybe we would be better off accepting that the FED alone does not run the economy, nor can it affect prosperity.

  10. Bill Frank

    Great in depth piece with lots of substance. However, when all is said and done, the Fed serves the interests of the financial elite, period. Meet the new boss, same as the old boss.

  11. kevinearick

    Credit History w Tuning Interference

    From labor perspective, the empire is background noise, largely to be tuned out. Your person is the adjustment. To the extent you require gravity, let the empire see you, with a public profile built for the purpose. The wave is a derivative of a rocking lever on a rotating fulcrum. What is the difference between a photon and an electron? What does the perception of speed have to do with mass?

    If you look at your History book, pick your poison, the empire operates on the assumption of transformational leaders, scapegoats in linear time. If you remove those monochromatic lenses, you will see otherwise. Funny, how swapping the leader of the parade does not alter its direction or momentum. In war, the clothes come off, you see the depravity of empire group competition and the self-reliance escaping it, through implicit cooperation. An empire is a distillery.

    Don’t ignore the nature of gravity that the armature is resting upon to feed the circuit. What is the character of credit issuance? What is the feedback?

    “World War I was over, America’s industrial might was coming of age with the rise of the auto industry and the nascent communications industry, Wall Street was booming…”

    “…the landscape was changing rapidly, from agrarian to urban…”

    “Prohibition was beginning, but so was the roaring lifestyle that came from flouting of Prohibition and the culture that produced it.”

    “Roosevelt, elected to his [THIRD] term, again by a landslide, was preparing the United States, pushing through the Export Control Act to stop the shipment of war materials overseas.”

    “…by 1944, twelve million Americans were in uniform; war production represented 44 percent of Gross National Product; there was almost nineteen million more workers than there had been five years earlier…”

    “…counseling sightless veterans on the career possibilities in insurance, mortgage sales, and car financing…”

    “They helped convert a wartime economy into the most powerful peacetime economy in history…”

    …a perpetual war machine in a positive feedback loop with Wall Street false promises, money with nowhere to go but stupid. That is Main Street America blaming Wall Street for its own participation in credit misdirection, liar’s poker with a stacked deck. What do you expect Yellen to do?

    You have artificial real estate scarcity and price inflation on one side of the fulcrum, and artificial empire labor excess and price deflation on the other. Yellen has no idea what you are going to do next, unless you choose to be an empire robot and validate her equations, which you may or may not want to do depending upon your development.

    To the extent your idea of fun is related to empire money, depression is the only possible outcome, because empires what they cannot have and disregard what they do have, with increasing speed. Nature is the problem and the solution. Don’t embed empire real estate prices into your food and expect a happy outcome. Sooner or later, you get run over by the wheel of your own creation.

    The empire pays you to be stupid; tune it out.

    1. kevinearick

      anon y’mouse:

      you must be new.

      you cannot afford to sit and wait for me to post, nor can I sit and wait for you to comment.

      if you look back in the record, forward, I am responding.

      whether you are looking backward or forward depends upon your perspective.

      balance in all things…

  12. Hugh

    What we need to do is end kleptocracy. Ending that would also mean ending the Fed.

    I know that this risks placing me outside the conversation but the risk of discussions like this one is that it gives credence and respectability to an institution that is inherently kleptocratic.

    The Fed is essentially a private banking cartel with a thin veneer of governmental overlay. Through its money creation powers, it backs the action of private banks. This action is the extraction of interest on loans which is essentially a funnel of wealth from workers’ labor to the rentier rich. And when it all went bust as it did in 2008, the Fed/private banking cartel used this same money creation power to bail out the entire banking sector, i.e. itself. While Paulson was talking martial law to push through the $700 billion TARP, Bernanke was already running a much bigger program that vitiated the whole rationale for the TARP (hence if you will remember, the original purpose of the TARP was dumped in favor of the scatter shot uses it was eventually put to). And Bernanke did not stop there. He ran a host of multi-trillion dollar programs, all with the purpose of bailing out the banks, as opposed to their tens of millions of victims.

    In this context, does it really matter whether Yellen will continue 95% or 96% of the private banking cartel agenda? Yellen who never saw the housing bust or the derivatives driven meltdown coming, despite holding major posts at the Fed before, during, and after these events, supported Bernanke’s policies, backed the repeal of Glass-Steagall, and favors the Chained CPI route to gut Social Security.

    If Yellen had not been a loyal servant of kleptocracy all of her career, she would never have had her career or now be in line for the Chairmanship of the Fed. What she could do is irrelevant. What she will do is serve the interests of the banks, as the head of the country’s private banking cartel and the kleptocrats who profit from them.

    Discussing how to reform the Fed is a little like discussing how to reform piracy. The only real way to reform it is to end it.

    1. MikeNY

      I am sympathetic to what you say. Perhaps we differ on the degree to which Fed officials *know* that they work for a kleptocracy. I suspect they still believe in their neoliberal model, even though it has patently stopped working for most Americans.

      And perhaps I’m more fearful that 1793 follows 1789.

      1. Hugh

        I am talking about ending kleptocracy. Kleptocracy is a class, economic, and political system. I am talking about ending the system of privilege which defines our elites, ending the looting and the large concentrations of destructive wealth it produces, and taking back the political system. In part, this would entail folding the monetary and regulatory functions of the Fed back into the Treasury. I think banking should be run as a public utility offering plain vanilla products. It doesn’t especially matter to me if this is public, private, or a mixture of the two.

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