The Federal Reserve and Boom-Bust Monetary Policy

Back in January, I spoke with Cheddar about market instability and put much of the blame on the Federal Reserve. Simply stated, I fear we have a bubble thanks to years and years (and years and years) of easy money and artificially low interest rates.

To be sure, I also noted that there are other policies that could be spooking financial markets.

But I do think monetary policy is the big threat. Mistakes by the Fed sooner or later cause recessions (and the false booms that are the leading indicator of future downturns).

Mistakes by Congress, by contrast, “merely” cause slower growth.

In this next clip from the interview, I offer guarded praise to the Fed (not my usual position!) for trying to unwind the easy-money policies from earlier this decade and therefore “normalize” interest rates (i.e., letting rates climb to the market-determined level).

For those interested in the downside risks of easy money, I strongly endorse these cautionary observations from a British central banker.

My modest contribution to the discussion was when I mentioned in the interview that we wouldn’t be in the tough position of having to let interest rates climb if we didn’t make the mistake of keeping them artificially low. Especially for such a long period of time.

My motive for addressing this topic today is that Robert Samuelson used his column in the Washington Post to launch an attack against Steve Moore.

Stephen Moore does not belong on the Federal Reserve Board… Just a decade ago, the U.S. and world economies suffered the worst slumps since World War II. What saved us then were the skilled interventions of the Fed under Chairman Ben S. Bernanke… Do we really want Moore to serve as the last bulkhead against an economic breakdown? …as a matter of prudence, we should assume economic reverses. If so, the Fed chief will become a crisis manager. That person should not be Stephen Moore.

I’ve been friends with Steve for a couple of decades, so I have a personal bias.

That being said, I would be arguing that Samuelson’s column is problematic for two reasons even if I never met Steve.

• First, he doesn’t acknowledge that the crisis last decade was caused in large part by easy-money policy from the Fed. Call me crazy, but I hardly think we should praise the central bank for dousing a fire that it helped to start.
• Second, he frets that Steve would be bad in a crisis, which presumably is a time when it might be appropriate for the Fed to be a “lender of last resort.”* But he offers zero evidence that Steve would be opposed to that approach.

For what it’s worth, I actually worry Steve would be too willing to go along with an easy-money approach. Indeed, I look forward to hectoring him in favor of hard money if he gets confirmed.

But this column isn’t about a nomination battle in DC. My role is to educate on public policy.

So let’s close by reviewing some excerpts from a column in the Wall Street Journal highlighting the work of Claudio Borio at the Bank for International Settlements.

In a 2015 paper Mr. Borio and colleagues examined 140 years of data from 38 countries and concluded that consumer-price deflation frequently coincides with healthy economic growth. If he’s right, central banks have spent years fighting disinflation or deflation when they shouldn’t have, and in the process they’ve endangered the economy more than they realize. “By keeping interest rates very, very, very low,” he warns, “you are contributing to the buildup of risks in the financial system through excessive credit growth, through excessive increases in asset prices, that at some point have to correct themselves. So what you have is a financial boom that necessarily at some point will turn into a bust because things have to adjust.” …It’s not that other economists are blind to financial instability. They’re just strangely unconcerned about it. “There are a number of proponents of secular stagnation who acknowledge, very explicitly, that low interest rates create problems for the future because they’re generating all these financial booms and busts,” Mr. Borio says. Yet they still believe central banks must set ultralow short-term rates to support economic growth—and if that destabilizes the financial system, it’s the will of the economic gods.

Amen. I also recommend this column and this column for further information on how central bankers are endangering prosperity.

P.S. For a skeptical history of the Federal Reserve, click here. If you prefer Fed-mocking videos, click here and here.

P.P.S. I fear the European Central Bank has the same misguided policy. To make matters worse, policy makers in Europe have used easy money as an excuse to avoid the reforms that are needed to generate real growth.

P.P.P.S. Samuelson did recognize that defeating inflation was one of Reagan’s great accomplishments.

*For institutions with liquidity problems. Institutions with solvency problems should be shut down using the FDIC-resolution approach.