Wednesday, October 15, 2008

Not The Right Stuff?

Harold A. Black


This article appeared in the Knoxville News-Sentinel on September 7, 2008


Milton Friedman and Anna Schwartz in their classic "A Monetary History of the United States" assert that the Federal Reserve's perverse monetary policies in response to the stock market crash of 1929 led to the Great Depression. Current Fed chairman, Ben Bernanke in a 2002 speech honoring Friedman on his 90th birthday acknowledged the Fed’s responsibility when he said to Friedman, "You were right, we did it. But thanks to you, we won't do it again." However, earlier this year Schwartz took issue with Benanke when she proclaimed that the Fed was the cause of the current economic difficulties and that "The new group at the Fed is not equal to the problem that faces it." Dr. Schwartz was being kind. This Fed has not only demonstrated incompetence in its execution of monetary policy, it has also produced an equally dismal record in its regulatory actions.


Freidman/Schwartz contend that the central bank can either target interest rate levels or monetary growth, but not both. Targeting money growth frees up interest rates to solely respond to market forces and increases the variability in rates. Interest rate targeting is accomplished by continuing to increase liquidity into the economy which ultimately leads to inflation. It is apparent that the Fed is now led by a chairman who targets interest rates.


This Fed has exercised benign neglect with regard to inflation. Instead of seeing inflation as a monetary phenomena produced by monetary growth, Bernanke talks about "high levels of resource utilization" being responsible. As a result of misguided Fed policy, we've had the credit bubble, the dramatic fall in value of the dollar, the doubling of commodity and the economies of the United States and its trading partners facing both inflation and recession.


As a regulator, Bernanke has acted like a career bureaucrat interested in increasing his political power. Fed governors are appointed to 14 year terms. One governor is appointed to a four term as chairman. Once appointed, governors cannot be fired - only impeached. This gives the Fed some insulation against political pressures. However, this Fed has succumbed to the pressure to "do something." So it has given us basically meaningless regulations on subprime lending, expanded its power over investment banking in its aid to Bear Stearns, and expanded its influence over Freddie Mac and Fannie Mae. Even Alan Greenspan said the Fannie Mae/Freddie Mac bill was a bad one. Instead of directly addressing the problem and curbing in their powers, the bill actually increased their powers. The market has responded with a responding display of lack of confidence. Fannie and Freddie's stock continues to fall and their attempts to raise capital though bond sales have proven to be expensive.


I know that it is popular to blame the market in times of economic stress. But the market is responding to the regulatory constraints imposed by the government. It is particularly disappointing to see the response of Paulson the Treasury secretary and Bernanke at the Fed to increase the role of government rather than to move toward market solutions. This is reminiscent of the bailout policies during the Carter years. Indeed Paulson and Bernanke are vying with G. William Miller and Michael Blumenthal for the title of most incompetent economic team ever.

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