http://www.gata.org/node/7819
-- a business about which New York Fed President William Dudley refused
to answer questions five months ago:
http://www.gata.org/node/16341
* * *
The Federal Reserve Needs New Thinking
By Kevin Warsh
The Wall Street Journal
Thursday, August 24, 2016
http://www.wsj.com/articles/the-federal-reser...inking-14720...
The conduct of monetary policy in recent years has been deeply flawed.
U.S. economic growth lags prior recoveries, falling short of forecasts and
deteriorating in the most recent quarters. This week in Jackson Hole,
Wyoming, the Federal Reserve Bank of Kansas City hosts the world's leading
central bankers and academics to consider monetary reform. The task is timely
and consequential, but the Fed needs a broader reform agenda.
Policy makers around the world neither predicted nor can adequately
explain the reasons for current inflation readings below their targets. So it
is puzzling that so many academics are pushing to raise the current 2%
inflation target to a higher target of 3% or 4%. In the telling of the
economics guild, the Fed's leaders should descend from the Grand Tetons with
supreme assurance that their latest monetary policy invention will remedy the
economy's ills.
The Fed's leaders should not take the bait. Raising the inflation target is a
bad idea being considered at the wrong time for the wrong reasons.
A new inflation target would undermine the Fed's commitment to any policy
framework. It would please the denizens of Wall Street who pine for
still-looser Fed policy. And households would be understandably miffed to
receive a new lecture on unconventional monetary policy -- this one on the
benefits of higher prices.
A change in inflation targets would also add to the growing list of
excuses that rationalize the economic malaise: the persistent headwinds from
the crisis of the prior decade, the high-sounding slogan of "secular
stagnation," and the convenient recent alibi of Brexit.
A numeric change in the inflation target isn't real reform. It serves more
as subterfuge to distract from monetary, regulatory, and fiscal errors. A
robust reform agenda requires more rigorous review of recent policy choices
and significant changes in the Fed's tools, strategies, communications, and
governance.
Two major obstacles must be overcome: groupthink within the academic
economics guild, and the reluctance of central bankers to cede their new
power.
First, the economics guild pushed ill-considered new dogmas into the
mainstream of monetary policy. The Fed's mantra of data-dependence causes
erratic policy lurches in response to noisy data. Its medium-term policy
objectives are at odds with its compulsion to keep asset prices elevated. Its
inflation objectives are far more precise than the residual measurement
error. Its output-gap economic models are troublingly unreliable.
The Fed seeks to fix interest rates and control foreign-exchange rates
simultaneously -- an impossible task with the free flow of capital. Its
"forward guidance," promising low interest rates well into the
future, offers ambiguity in the name of clarity. It licenses a cacophony of
communications in the name of transparency. And it expresses grave concern
about income inequality while refusing to acknowledge that its policies
unfairly increased asset inequality.
The Fed often treats financial markets as a beast to be tamed, a cub
to be coddled, or a market to be manipulated. It appears in thrall to
financial markets, and financial markets are in thrall to the Fed, but only
one will get the last word. A simple, troubling fact: From the beginning of
2008 to the present, more than half of the increase in the value of the
S&P 500 occurred on the day of Federal Open Market Committee decisions.
The groupthink gathers adherents even as its successes become harder to
find. The guild tightens its grip when it should open its mind to new data
sources, new analytics, new economic models, new communication strategies,
and a new paradigm for policy.
The second obstacle to real reform is no less challenging. Real reform
should reverse the trend that makes the Fed a general purpose agency of
government. Many guild members believe that central bankers -- nonpartisan,
high-minded experts -- are particularly well-suited to expand their policy
remit. They fail to recognize that central bank power is permissible in a
democracy only when its scope is limited, its track record strong, and its
accountability assured.
The Fed is suffering from a marked downturn in public support. Citizens
are rightly concerned about the concentration of economic power at the
central bank. Long after the financial crisis, the Fed holds trillions of
dollars of assets that would otherwise be in private hands. And it appears to
make monetary policy with the purpose of managing financial asset prices,
including bolstering the share prices of public companies.
With the enactment of the Dodd-Frank Act, the Fed claims the mantle of
reform. It now micromanages big banks and effectively caps their rate of
return. The biggest banks' growth in market share corresponds to that of their
principal regulator. They are joint-venture partners with the Fed, serving as
quasi-public utilities. As the dispenser of fault and favor, the Fed is
contributing to the public perception of an unfair, inequitable economic
system. Real reform this is not.
Most gathered in Jackson Hole will judge that the Fed's aggressive actions
are necessary and wise. Even if that were true, the Fed finds itself in an
increasingly untenable position. Congress will tag the Fed for its failures,
and the public will assail the Fed for favoritism for its ostensible
successes.
In the best of circumstances, the U.S. economy will accelerate to
"escape velocity." In that event the Fed might get the benefit of
the public doubt.
If, as is more likely, the economy is closer to recession than resurgence,
the Fed is poorly positioned to respond with force, efficacy, and
credibility. The Fed is vulnerable. Its recent centennial as our nation's
central bank should not be confused with its permanent acceptance in the
American political system.
-----
Mr. Warsh, a former member of the Federal Reserve board, is a
distinguished visiting fellow in economics at Stanford University's Hoover
Institution.
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