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Ruling the Fed: Republicans Attacking Yellen Should Be Careful What They Wish for
Fed chair Janet Yellen testified this week on the state of the economy. The only interesting thing to come of it was some sharp-edged criticism by Republican members of the House Financial Services Committee. That includes committee chair Jeb Hensarling, who said, “Fed reforms are needed . . . Fed reforms are coming.”
Senator Rand Paul, for one, is pushing a bill to audit the Fed, by which he means auditing the Fed’s policies and discussions. But Yellen and other Fed big shots fiercely oppose any rules that might be imposed on the central bank by Congress.
Now, down through the years, the Fed has always resisted rules in the name of independence from political pressure. But there’s an interesting back story here.
In the early 1970s, President Nixon allegedly (it’s never been proven) ordered then-Fed chair Arthur Burns to goose the money supply to spur the economy and help the Nixon reelection effort. This story becomes even creepier, since Nixon and his entourage destroyed the dollar and launched double-digit inflation by breaking the gold-dollar link established in 1944 at Bretton Woods.
So the Fed has a point about politics.
Later in the 1970s, however, a Democratic Congress voted for the Humphrey-Hawkins bill, which mandated the Fed to keep both unemployment and inflation down. That became law. And of course, for most of the ’70s and early ’80s, the dollar sank lower while unemployment and inflation ratcheted higher. That prompted Republicans to jawbone the Fed to establish money-supply targets, which followed the dictum of Nobelist Milton Friedman (who wanted to replace the Fed with a computer).
For a while, Fed head Paul Volcker published money-supply targets. But Ronald Reagan told Volcker to do whatever was needed to conquer inflation while he and Congress reduced marginal tax rates and reignited economic growth. The Fed had no new rules. But for 20 years, the economy worked beautifully.
Then the rule story shifts to the financial meltdown of 2008, when the Fed went wild. It pushed the target rate to zero and flooded the banking system with over $4 trillion in new reserves. That really didn’t work. Most of the Fed’s money creation went unused; it was turned around by banks and placed on deposit at the Fed.
Former Dallas Fed president Bob McTeer points out that the money supply never ballooned out of control and the Fed didn’t pump up anything, because the velocity (or turnover) of money collapsed. Economist John Ryding calculates that over the past six years, while the Fed’s balance sheet grew near 17 percent a year, the M2 money supply increased only 6 percent annually, in line with the long-term trend, while money velocity fell 2 percent yearly and nominal GDP grew by roughly 4 percent. There was no Big Bang, and also no inflation.
Today, Janet Yellen may rightly or wrongly be associated with liberal Democrats, but a key point is that she talks dovish and acts hawkish. She shut down so-called QE reserve creation, a surprise to many.
And lately, the U.S. dollar has gone up while oil and commodity prices have gone down. As a result, an improving economy is trying to reach 3 percent growth.
So Republicans attacking Yellen and calling for higher interest rates should be careful what they wish for. A strong dollar and low energy costs have put the economy in a good place.
Now, if President Obama would agree with the GOP to slash the corporate tax, the economy might grow at 4 or 5 percent with a stronger dollar and even lower commodity prices. Wouldn’t that be ironic? Too bad Obama won’t agree to a serious corporate tax cut.
As for rules and the Fed, there are a bunch of proposals out there: There’s the inflation-fighting Taylor rule, which seemed to work in the 1980s and ’90s. There’s a gold-commodity-King Dollar price rule (which I favor) that also worked in the ’80s and ’90s. There’s the new-monetarist nominal-GDP-growth rule, although the trouble here is that velocity keeps falling and money GDP has gone nowhere. Alan Greenspan (!) is actually telling people that gold is the only true currency. And Professor Taylor himself is suggesting that the Fed could create its own rule, any rule, but would have to answer to Congress if it ever went off it.
At the end of the day, the economic incentives from lower tax rates and regulatory burdens are the right levers to promote faster growth. And central banks should focus on sound currencies and price stability.
Looking at a renewed King Dollar and low U.S. inflation, the Fed seems to have done its job. So either 1) it’s a miracle or 2) the Fed actually knows what it’s doing.
You choose.
Published in General
LK – I chooses option 3, neither.
Compared to the basket cases of the yen and euro the dollar is the best house in a bad neighborhood, for now, creating some relative strength.
I agree with you that raising interest rates would collapse the house of cards we have built, but that does not excuse the fact that we created a monetary house of cards.
Zero interest rates and QE are great for the market and Wall street but ask the average guy making $10 an hour how he is doing.
Do you honestly think that the recent drop in oil has anything to do with awesome monetary policy on our side? Wouldn’t you guess that it has something to do with certain oil producers cranking up to punish the Russians and hurt shale as a bonus?
So, let’s be honest about what is going on. Cheap money is helping Wall street and making headline numbers (Dow close) look good at the expense of those who actually produce something, the dollar is up because other currencies are a mess, oil is down because oil producers want to hurt Russia and shale, and inflation in healthcare/education/food is real for working Americans
The median household income is around $50k. If our side wants to win we need to think about what this means when it comes to policy
Couldn’t be more obvious.
Audit the Fed.
The audit the Fed stuff is nonsense born out of Ron Paul’s fantasies. So no wonder it’s being pushed by his son.
When ignorant politicians get into the monetary business, expect nothing short of disaster.
As for what the Fed did in 2008, it was text-book Milton Friedman.
Be careful what you wish for, because politicians neither understand anything, nor wish for anything other than votes. The same applies to Democratic or Republican politicians.
We keep hearing about this amazing “recovery”. Bottom line: 4th Q GDP was just revised downward to 2.2%. That is stagnation, at best.
After 6 years of the Fed overseeing the biggest financial experiment in human history, I don’t know anyone who would say the economy is humming. The latest numbers are devastating.
1.Manufacturing data is sluggish.
2.The National Debt has literally doubled in 6 years. At over $18 Trillion, the debt per tax payer is over $154,000.
3.Multi-national companies had a series of disappointing earning results.
4.The trade gap has widened. U.S. products are becoming more expensive for foreign markets.
5.Durable orders are down.
6.Wages are lower than 2007.
7.Business investments has cooled. Business spending on equipment fell at the largest contraction since early 2009.
8.U.S. Consumer spending just recorded it’s biggest decline since late 2009, with cheaper gas not translating to higher activity.
9.The Labor-Force Participation Rate is at the lowest level in almost 40 years. (Fewer people in the workforce lowers Unemployment Rate)
Technically the economy is in better shape than 2009. You can rise up from the floor of the Mariana Trench, but still be well below sea level.
I think those who have been cheerleading the economy for partisan reasons for so long have been attempting a little Goebells doctrine: People will believe any lie as long as it’s repeated often enough.
Some Fed rules should be rewritten. For example, when real rates are negative, you could say that the Fed has “taxed” savers and transferred some of their wealth to borrowers (and to banks). In doing this, the Fed has taxed a segment of the population without having to worry about a single vote. Isn’t this taxation without representation? The main difference with conventional taxation is that the wealth went straight from saver to borrower, bypassing the Treasury entirely. Perhaps a more efficient way to tax, but one which is not backed by a constitutional vote.
In addition, when we speak of Fed independence, the Fed should also be independent of Wall Street, not just of Congress. Its actions should come as a surprise to Wall Street, as was the case in the past, in order to restore the proper attitude towards risk taking. Nowadays, we have the sentiment that some top bankers and asset managers have a direct line to the Fed.
Finally, the Fed’s intervention (directly or via proxies) in asset markets should be completely transparent. Investors need to know if the value of their holdings is influenced by Fed interventions and to what extent.
This sounds rather Gruberesque, AIG, are you saying that We are all too stupid and dumb to understand that the monetary technocrats of the FED representing the interests of the ruling class? If so, I would ask you to look at the who has benefited from the artificially low interest rates: The Federal Government has benefited by $1-2 Trillion in lower interest costs at the expense of retirees, savers and pension funds. Eventually the politics of this hidden transfer of wealth begin to have an impact. I believe the call for transparency had been bought on by the FED by itself.
Yes
Everyone
Really? How’s your 401K doing?
What’s not transparent about it?
They most certainly aren’t. It’s a slow recovery, a late recovery, but “devastating” is plain old not true.
Manufacturing output is at record levels.
And the cost of debt has halved.
The stock market is at record levels.
Trade gap means nothing.
They’re at normal growth rates
Largest contraction since 2009 means nothing.
So you find 1 month with low growth, and then forget all the consecutive years of high growth.
Labor force participation rate started declining in about 1980.
Hmm…almost everything is at record levels.
You can make the case that it’s a slower than normal recovery, and it is. But all this other “doom” stuff is just false.
Yes, as I’m sure you have…no partisan reasons whatsoever…in pretending everything is going bad ;)
You don’t honestly think this, do you? Sure, I’m benefiting on my 401K, brokerage account, and every time I refinance my mortgage at a lower rate……..but is this helping the bottom half of the income spectrum as they get zero in their savings account and they see rents increase every year?
If zero interest rates and ongoing QE were some magic fix everything, why was it only with the financial crisis that we went down this route? Shouldn’t we have started it when the Fed was founded 100 years ago? Like many government policies it is creating artificial winners and losers, and those in the mid and lower quintiles of the income spectrum are losing.
My 401-K, similar to the ones that I assist in managing are doing better relative to what? The 15 year return of the S&P 500 is 4.91%. The historic returns for US Equities generally exceed 7-8%. Individual returns depend on when an investor entered the market. So if you entered the market in 2009 then you probably do think the world is on fire. We are in one of the longest cycles where we have not seen a market pullback of 10% or greater. One reason for this is that every time the FED hinted or moved to raise rates, Mr. Market would crater and the FED would back off on their interest rate statements. I believe this was done to protect the Obama administration in the 2010 and 2012 elections. I am less sanguine the FED will move to protect a Republican president in 2016. Eventually some politician will have to take one for the team, in investment parley we call this mean reversion.
It has been well documented that the winners have been the Federal Government in lower deficit costs, and the international banking structure.. The losers have been savers, pension funds, insurance companies and foreign governments. Bill Mauldin publishes a weekly newsletter and from time to time will publish the ZIRP winners and losers chart.
The Fed hasn’t “done it’s job” until interest rates return to somewhere near their historic norms. Until then the music is still playing, but the question has always been what happens when the music stops.
Like Pleated Pant says, if ZIRP and QE are such magical fixes for the economy, why were they only instituted in a crisis? In fact, if the Fed’s job is “done”, why not leave interest rates at zero forever? Because, obviously, you can’t borrow an infinite amount of money. At some point no one will take on your debt, so the question has never been what the Fed can produce with cheap money; goosing short term results and blowing asset bubbles, like the stock market, isn’t rocket science. It’s what happens when interest rates return to historic norms, either voluntarily or by force.
“Sound currency?” That’s one the value of which can’t be manipulated by central bankers. The whole point of the Fed is that it can, allegedly, produce economic benefits by playing with the value of the dollar, i.e. “doing it’s job” is only possible with an unsound currency.
Decades from now, when we are all using digital cryptocurrencies with their own monetary algorithms, students will read economic history and marvel at the silly notion that monetary policy would be determined by the whims of a few unelected elites.
We will be freely able to move between currencies with monetary algorithms hard coded into them, algorithms that could have been conceived by someone in their basement.
Imagine monetary algorithms competing with each other in a free market! This will be truly revolutionary.
From what I’ve read, audit the Fed, has more to do with secret cabals than evaluating the effectiveness of the institution.
If I had my druthers, I would eliminate the employment mandate part of Humphrey Hawkins.
I’m all for rules. But what rules? How do you hold the Fed accountable?
It was set up to limit accountability. And it’s all a mystery to me on how it works.
For example, we talk a lot about the “Chairman of the Federal Reserve”. Well, the full title is, “Chair of the Board of Governors of the Federal Reserve System.” Supposedly this Chairman has one vote out of seven on that board. So how come you never hear about those other board members? I never hear about the Chair getting out voted.
By dint of her chairmanship, she’s also chair of the “Federal Open Market Committee”. In fact, here’s a chart from Wikipedia, but which is published by the Board of Governors.
No wonder there are calls to audit the Fed. No wonder there are conspiracy theories. What a mess!!
What do rents have to do with this? Are you saying there’s a…high inflation rate? Cause that’s not true.
So…don’t put your money in a savings account then. Saving accounts at best a hedge against inflation. Given the very low inflation numbers, of course they’re going to provide very low returns.
The Fed’s response was aimed at preventing deflation. It was textbook Milton Friedman.
We didn’t do this in the past because we didn’t know how to control inflation in the past. This wasn’t “discovered” until Milton Friedman theorized it in the 70s, and his policy prescriptions were implemented in the 1980s. Since then, we didn’t have a massive deflationary pressure like we did in 2008.
So this…is…new. But it’s “our” idea: i.e. it’s “conservative” economists who came up with this solution. And it’s intent is not to cause a recovery, or to get the economy back on track or anything of the sort. It’s intent is to prevent a deflation, like happened in the 1930s.
Which is why you might want to keep the Fed out of the hands of politicians then ;)
If you really believe this ;)
A newsletter!! Well, what better documentation than that is needed?
The winners have been everyone. Without what the Fed did, there would have been major deflation.
Hmm…because they’re not “fixes for the economy”.
In this case they were intended to stop deflation. It’s as basic as a supply and demand curve. People only look at what the Fed has done in terms of the supply. But they never look at the…demand…side. What has demand for dollars done?
This is my point: people don’t seem to know what the Fed has done in the first place, never-mind try to figure out some politician ought to be “auditing” them for.
Well the Fed doesn’t seem to know either, because Yellen keeps talking not only about inflation targets, but unemployment targets as well, which definitely involve fixing the economy. Somebody should let her know. Maybe if we write it in bold she’ll get the message.
In any case, the demand for dollars has gone to infinity, as anything would when you make its price zero. If I could borrow money from the Fed at zero percent interest, then loan it out in mortgages at 4%, or play the stock market with it, or buy Treasuries at 1.5%, I’d borrow as much money as I could. Unfortunately, that deal is only available to bankers, who are making a killing, at least until it all goes bust. But then we’ll bail them out as being “too big too fail” so it doesn’t matter anyway. What a deal.
Unless and until the Fed raises interest rates to historic norms, any conclusions about what it’s done are premature. It’s as basic as not judging someone on how well he’s lived on the credit card debt he’s racked up, but what happens when he gets around to actually paying those cards off.
Really, what has the Fed done that is so impressive? It’s handed out cheap money pretty much non-stop for the last 8 years. How hard is that?
Bold only works on the internet.
Preventing a major deflation does both things.
You’ve got it precisely backwards. People moved out of stocks and other investments, which increased the demand for dollars. And hence required a change in the supply. Much of it was international as well.
And, these “deals” are available to you as well.
Again, you’re only looking at half the equation, and forgetting the other half. So this means nothing.
Hmm…that’s the job of the Fed. Money supply.
Here’s Milton Friedman:
So the argument could easily be made, that a more expansive monetary policy was needed (now the worst has already passed).
But this isn’t some “conspiracy theory” to benefit this group or that group. That’s absurd nonsense.
This is basic supply and demand, in keeping stable inflation rates. Since the inflation rate is actually far lower than normal, this indicates a monetary policy is still tighter than what it should be.
If people simply fail to understand that money itself has a supply and demand curve, and that “stable” implies changing your supply when demand changes…then there’s no way they’re going to know what the Fed did.