Easy Money from the Federal Reserve Is Not the Solution for America’s Economic Problems
Allen Meltzer, an economist at Carnegie Mellon University, writes today in the Wall Street Journal about the Fed’s worrisome announcement that it will continue the easy-money policy of artificially low interest rates.
Professor Meltzer’s key point (at least to me) is that the economy is weak because of too much government intervention and too much federal spending, and you don’t solve those problems with a loose-money policy – especially since banks already are sitting on $1.6 trillion of excess reserves. (Why lend money when the economy is weak and you may not get repaid?)
Meltzer then outlines some of the reforms that would boost growth, all of which are desirable, albeit a bit tame for my tastes:
[T]he United States does not have the kind of problems that printing more money will cure. Banks currently hold more than $1.6 trillion of idle reserves at the Fed. Banks can use those idle reserves to create enormous amounts of money. Interest rates on federal funds remain near zero. Longer-term interest rates on Treasurys are at record lows. What reason can there be for adding more excess reserves? The main effect would be a further devaluation of the dollar against competing currencies and gold, followed by a rise in the price of oil and other imports. …Money growth (M2) reached 10% for the past six months, presaging more inflation ahead.
…What we need most is confidence in our future. That calls for:
- Reducing corporate tax rates permanently to encourage investment (paid for by closing loopholes).
- Agreeing on long-term reductions in entitlement spending.
- A five-year moratorium on new regulations affecting energy, environment, health and finance.
- An explicit inflation target between zero and 2% to force the Fed to pay more attention to the medium term and to increase public confidence that we will not experience runaway inflation.
The president is wrong to pose the issue as more taxes for millionaires to pay for more redistribution now. That path leads to future crises because higher taxes support the low productivity growth of the welfare state, delay the transition to export-led growth, and do not reduce future budget liabilities enough.
Meltzer’s final point about the futility of class-warfare taxes is very important. He doesn’t use the term, but he’s making a Laffer Curve argument. Simply stated, if punitive tax rates cause investors, entrepreneurs, and small business owners to earn/declare less taxable income, then the government won’t collect as much money as predicted by the Joint Committee on Taxation’s simplistic models.
Of course, Obama said in 2008 than he wanted high tax rates for reasons of “fairness,” even if such policies didn’t lead to more tax revenue. That destructive mentality probably helps explain why not only banks, but also other companies, are sitting on cash and afraid to make significant investments.
But if you really want to understand how Obama’s policies are causing “regime uncertainty,” this cartoon is spot on.
The Ben Bernanke Variety Hour
April 27th begins a new chapter in Federal Reserve history: the Fed joins other major central banks in having a press conference after its monetary policy meetings (the Federal Open Market Committee). Apparently the record lows in public support for the Fed, along with rising gas and food prices, have driven Bernanke to attempt to change the narrative. After all, his appearance on “60 Minutes” did wonders for the Fed’s reputation. I’m excited to hear even more about his childhood in Dillon, South Carolina or his time working at South of the Border. Maybe an enterprising reporter could ask how much menu prices at South of the Border have increased since Bernanke took over the Fed.
Perhaps you’ve noticed that I don’t have high expectations for his press conference. It is probably fair to say that no Federal Reserve Chair has had as much public exposure as Bernanke. Yet with all those public appearances, he has consistently managed to avoid any real discussion about the costs and benefits of the Fed’s actions. Are we likely to hear concern about food and gas prices, and how such are being driven by loose money? Probably not…just more on how increasing world demand is to blame. Just like it was the “global savings glut” that drove interest rates earlier this decade, it is always somebody else’s fault — never the Fed’s. They are capable of only good.
Hopefully Bernanke will at least avoid the Obama line that it is those “speculators” that are behind the increase in energy prices. After all, if we believe the governments of Europe, those evil speculators brought down Greece too.
As per usual, I truly hope I’m wrong here. Bernanke has a real opportunity to be honest and straightforward with the American public. We don’t need another lecture. We need to hear that the Fed isn’t a slave to some imaginary Phillips Curve or that we can’t have inflation with slack in the economy (where was Bernanke in the 1970s?). The real risk is that Bernanke uses the press conference to drown out the many voices of concern and dissent on the FOMC. Which, of course, would be a real irony given all of Bernanke’s talk about “democratizing” the Fed when he first became chair.
Federal Reserve to Hold Press Conferences
Today Federal Reserve Chair Ben Bernanke announced he would hold four annual press conferences, after select meetings of the Federal Open Market Committee. The first such meeting will be on April 27 and will be webcast.
While I generally haven’t been a fan of Bernanke’s policy decisions, many of his “process” decisions, such as holding these press conferences, have been moves in the right direction of greater Fed communication with the public. The Fed took some bold moves during and since the financial crisis — often without a word to the public. Indeed, it is interesting that this announcement comes only a few days after the Supreme Court refused to hear the appeal of the Bloomberg suit demanding Fed disclosure of banks assisted during the crisis.
It remains to be seen, however, if these press briefings provide any real substance or explanation of the Fed’s actions. After all, I don’t think Bernanke’s appearance on “60 Minutes” really changed anyone’s mind. But then again, the interview was fairly devoid of actual substance. For these future press briefings to have any real value, the reporters involved are going to have to ask tough, insightful questions, rather than the fluff Bernanke is used to.
Then perhaps the real problem with the Fed’s communication strategy is that it has been only one-way. By now we all know that Bernanke didn’t want to be the Fed chair that oversaw “Great Depression II,” or that he’s just a simple guy from Dillon, SC. But how about some sense that Bernanke is not just lecturing, but listening? Where’s the evidence that he understands the squeeze that rising food and gas prices put on the middle class? Where’s the evidence that he gets that the “Phillips Curve” isn’t real?
I am going to hold out for the best. Maybe these briefings will provide some substance where previous appearances have not.
Take Off the Blinders: Diversity Demands Educational Freedom
Yesterday, FoxNews.com posted a story on what appears to be a growing problem for public school systems across the country: accommodating Muslim holidays. Unfortunately, the report didn’t contain the solution to the problem. It did, though, contain a very succinct discussion of the root of the problem; an example of the good intent that causes people to ignore the problem; and the kind of “solution” that is ultimately at odds with the most basic of American values.
A quote from New York City mayor Michael Bloomberg captured the essence of the problem:
One of the problems you have with a diverse city is that if you close the schools for every single holiday, there won’t be any school.
There you have the basic conundrum in a nutshell: Whenever you have a diverse population — whether in a hamlet, city, state, or nation — and everyone has to support a single system of government schools, you cannot possibly treat all people – or even most of them — equally. Either there are winners and losers, or nobody gets anything.
Understanding why public schooling can’t handle diversity — why, simply, one size can’t fit all — is really basic common sense. So why isn’t there more outrage over, or even just recognition of, the utter illogic of our education system? Mohamed Elibiary, President and CEO of the Freedom and Justice Foundation, illustrated the attitude that likely causes lots of Americans to wear blinders:
I’m a little torn. I want Muslims to be getting the same recognition as other Americans, but at the same time I don’t want to see public education systems be a battleground between religious identities, because then we’re missing the point of why we have a public education system to begin with.
No doubt many people truly believe as Elibiary does: that a major purpose of public schooling is to bring diverse people together and, by doing so, unify them. It’s a fine intention, but also a classic case of intent not matching reality. Indeed, the reality is often very much the opposite. Rather than unifying people, public schooling has repeatedly forced religious conflict (as well as conflict over race, ethnicity, political philosophy, curriculum, and on and on).
Congress to Expand Deposit Insurance
While I never had much hope that this Congress would actually fix the real causes of the financial crisis – loose monetary policy, Fannie/Freddie – I had hoped that they wouldn’t do a lot to make an already bad situation worse. Boy, was that hope naive.
Take the area of federally provided deposit insurance. There is a massive amount of scholarly work, much of it empirical, that demonstrates that expanding the level and scope of deposit insurance results in more frequent and severe financial crises. So what is Congress considering? Yes, you guessed it: expanded deposit insurance.
Recall during the financial crisis Congress raised the coverage limit to $250,000 – forget that there were never any premiums charged ahead of time for this coverage. The FDIC also, without any basis in law, offered unlimited coverage to non-interest bearing accounts, targeted mostly at business customers. While these expansions may have brought the system some short term stability, they come at the cost of considerable long term instability.
Congress is also making the misguided change of basing insurance premiums on total assets rather than total deposits. This will punish banks for relying on sources of funding other than deposits, giving banks an incentive to shift their funding toward deposits, putting the taxpayer ultimately at even greater risk.
So why all these expanded bank guarantees? Smaller banks view these as changes that would give them a competitive advantage relative to larger banks. After all community and regional banks are far more dependent on deposits as a source of funds. And while big banks are damaged politically, the smaller banks, despite their higher failure rates, have managed to maintain their political ability to shift the costs of their risk-taking onto the backs of the taxpayer.
Public Wants Fed Audit
A new Rasmussen poll has 80% of the American public supporting an audit of the Federal Reserve. Only 9% of the public oppose, with the rest unsure.
Unfortunately the poll did not ask specific questions over whether such an audit should cover monetary policy or just the Fed’s 2008 bailout activities. So while the poll is likely to keep pressure on Congress, during its conference negotiations over financial regulation, to retain some audit of the Fed, the likely result is that Congress will leave out any real, on-going audit of monetary policy.
After Sen. Bernie Sanders essentially gutted his own amendment, Senator Dodd and the Obama administration agreed to a minor audit of the Fed’s emergency lending programs. Ron Paul, sponsor of the House version of the audit, quickly labeled this as a “sell-out”. Fortunately Congressman Paul looks to be a House conferee on the bill, so some hope remains of a full audit being included.
Opponents of a Fed audit claim this would undermine the Fed’s political independence. Sadly what opponents, including many economists, are missing is that the Fed is currently far from independent of politics. This is again an area where the public gets what the experts miss, as just 20% of poll respondents thought the Fed has acted independently. A full 60% felt the Fed was too much influenced by the President, getting at a crucial point concerning Fed independence: it is independence from the Executive branch that is critical.
How ObamaCare Would Keep the Poor Poor
Suppose you’re a family of four at or near the federal poverty level. Under current law, if you earn an additional dollar, you get to keep around 60-70 cents.
Under the House and Senate health care bills, however, you would get to keep maybe 38 cents. Or 26 cents. Or maybe just 18 cents.
The following graph (from my recent study, “Obama’s Prescription for Low-Wage Workers: High Implicit Taxes, Higher Premiums”) shows that under the House and Senate bills, the combination of (1) a mandate tax and (2) subsidies that disappear as income rises would impose implicit tax rates on poor families that reach as high as 82 percent over broad ranges of income.
This graph actually smooths out some rather bumpy implicit tax rates that spike as high as 174 percent.
In the 1980s and 1990s, the public saw that too-generous government subsidies can actually trap people in a cycle of poverty and dependence. President Obama and his congressional allies seem not to have learned that lesson.
Wednesday Links
- Nat Hentoff reports on racism in Cuba.
- Federal judge dismisses charges against Blackwater guards over the killing of 17 in Baghdad. David Isenberg: “The fact that the Blackwater contractors are not getting a trial will only serve to further increase suspicion of and hostility towards security contractors. It is going to be even more difficult for them to gain the trust of local populations or government officials in the countries they work in.”
- New report shows state and local government workers have higher average compensation levels than private workers.
- Podcast: “Televising and Subsidizing the Big Game” featuring Neal McCluskey. “Everybody should watch the National College Football Championship because whether you’re interested or not, you are paying for it,” he says.
Is Keynesian Stimulus Working?
In his Brookings Institution speech yesterday, President Obama called for more Keynesian-style spending stimulus for the economy, including increased investment on government projects and expanded subsidy payments to the unemployed and state governments. The package might cost $150 billion or more.
The president said that we’ve had to “spend our way out of this recession.” We’ve certainly had massive spending, but it doesn’t seem to have helped the economy, as the 10 percent unemployment rate attests to.
It’s not just that the Obama “stimulus” package from February has apparently failed. The total Keynesian stimulus is not measured by the spending in that bill only, but by the total size of federal government deficits.
The chart shows that while the federal deficit (the total ”stimulus” amount) has skyrocketed over the last three years, the unemployment rate has more than doubled. (The unemployment rate is the fiscal year average. Two months are included for FY2010.)
The total Keynesian stimulus of recent years has included the Bush stimulus bill in early 2008, TARP, large increases in regular appropriations, soaring entitlement spending, the Obama stimulus package from February, rising unemployment benefits, and falling revenues, which are “automatic stabilizers” according to Keynesian theory.
The deficit-fueled Keynesian approach to recovery is not working. The time is long overdue for the Democrats in Congress and advisers in the White House to reconsider their Keynesian beliefs and to start entertaining some market-oriented policies to get the economy moving again.
Remembering the Reporter Who Sued the Fed
With the Washington Post and other mainstream media outlets publishing endless defenses of “Federal Reserve independence” and proclaiming the Fed as savior of our financial system, it is all to easy to dismiss much of the media as simply defenders of the status quo. There were many, however, willing to challenge this orthodoxy. Standing out among them was Mark Pittman, reporter for Bloomberg. It was Mr. Pittman who sued the Federal Reserve, winning a victory on August 24, as the Manhattan Federal Court allowed the suit to proceed. Sadly, Mark Pittman passed away on November 25th.
Mark Pittman and his employer, Bloomberg News, sought details on the Federal Reserve’s numerous special lending facilities. Which firms were getting loans, and for how much and at what terms? These were all details the American public were entitled to, yet were denied by the Federal Reserve. We all remember the Fed’s warnings that if AIG counter-parties were named, there would be market disruptions. Yet, after much public and Congressional pressure, those firms were named, with no adverse market consequences.
While Mark Pittman’s efforts will be greatly missed, his suit continues, as does the efforts by Rep. Ron Paul and others in Congress, to bring transparency to the activities of the Federal Reserve.
Monday Links
- Nancy Pelosi: “The power of Congress to regulate health care is essentially unlimited.”
- Since August 2008 the monetary base (bills in circulation plus bank credits at Federal Reserve banks) has increased by 137%. If not defused, this bomb will eventually explode into inflation.
- Federal spending just pushed the government’s debt over $12 trillion. Spending has soared so high that 40 percent of this year’s budget will be funded by borrowing.
- What the NFL can teach us about the War on Terror.
- Podcast: “The Rule of Law and the Fed“
Congress Grows Fed Up
The Wall Street Journal reported that Congress likes Fed Chairman Bernanke, but not the institution that he heads. There is growing consensus that the Fed needs to be reformed and restructured. Most notably, there are calls to strip the Fed of its supervisory authority. In practice, the new sentiment reflects the failure of the Fed to rein in risk taking by the largest banks.
The Fed is pushing back. One reserve bank president said that removing the Fed’s supervisory authority “would affect our ability to conduct monetary authority effectively.” He went on to say that without the supervisory authority, the Fed wouldn’t know enough about risks brewing in the economy. This argument is shop worn. The Fed had the authority. It fueled the housing boom with its monetary policy and failed to head off the banking crisis with its supervisory powers. And let us not forget the regional banking crises of the 1990s; the fallout of the Latin American debt crisis for Citibank; and others (e.g., the failure of Continental Illinois National Bank). All on the Fed’s watch.
Around the world, some central banks have supervisory authority over banks and some do not. There is no clear pattern for either monetary policy or bank regulation with respect to how the powers are structured and distributed. Other factors seem to matter much more. It would be useful to identify what they are.
Congress is moving a few deck chairs around as the ship sinks. No fundamental rethinking of bank regulation is occurring. The Fed is probably being made a scapegoat for Congress’s own failings. But that is how Washington works.
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