Wednesday, May 16, 2012

Our perplexing Fed

I am perplexed. I have great respect for the Federal Reserve and think that its framers were brilliant. Rather than leaving the central bank in the hands of politicians who would debase the currency as soon as they could, the Fed instead is independent and should be apolitical. Of course it isn’t, but in the main it has worked pretty well producing among the lowest rates of inflation in the world. The question is then why has this Fed been so irresponsible? The Fed is made up of really smart people and perhaps the least smart ones are sitting on the Board of Governors. I have known many of the Fed economists and many of its presidents, I cannot point to a single economist who was not very capable and only to one president that I was not certain about. This is not true for the governors but generally speaking all were fairly bright people. All at the Fed understand their mission and any of their websites will point it out. This is from the San Francisco Fed/s website: “What are the goals of U.S. monetary policy? Monetary policy has two basic goals: to promote "maximum" sustainable output and employment and to promote "stable" prices. These goals are prescribed in a 1977 amendment to the Federal Reserve Act.” The narrative goes on to say that the Fed can only pursue the goals of output and employment in the short run and to try to do it in the long run will not work. “Persistent attempts to expand the economy beyond its long-run growth path will press capacity constraints and lead to higher and higher inflation, without producing lower unemployment or higher output in the long run. In other words, not only are there no long-term gains from persistently pursuing expansionary policies, but there's also a price—higher inflation.” So the question is why has the Fed pursued a monetary policy that has debased the currency, exploded the monetary base and has laid the foundation for inflation? Also it has done this by keeping the Fed funds rate near zero in a no-growth economy. Doesn’t it know the consequences of its actions? The answer is yes it knows but it thinks that it can sop up the excess reserves when the economy starts to heat up. It created those excess reserves by purchasing asset backed securities from distressed markets and Treasurys directly from the Treasury. Again I have no trouble in the Fed buying securities from anyone other than the Treasury. But purchases from the Treasury are inflationary and are the source of the increased government spending. Why the Fed didn’t tell the administration to take a hike is beyond me. What I need someone to explain to me is why the Fed has done this in the first place. Surely, a collapsing dollar, hyperinflation and world wide inflationary recession cannot be the legacy that Bernanke has chosen. But that is the path he has put us on.

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