Bernanke on the Federal Reserve: "We Are Faking It."
Bernanke on July 10 delivered a classic Bernanke speech: 44 footnotes.
Title: "The First 100 Years of the Federal Reserve: The Policy Record, Lessons Learned, and Prospects for the Future." Setting: a conference sponsored by the National Bureau of Economic Research. The NBER is the #1 academic organization devoted to studying America's business cycles. It designates when recessions begin and end.
Here is where he summarizes his life's work. Here is where he justifies his actions in front of his peers. We should pay attention.
He called the FED "The Great Experiment."
In the words of one of the authors of the Federal Reserve Act, Robert Latham Owen, the Federal Reserve was established to "provide a means by which periodic panics which shake the American Republic and do it enormous injury shall be stopped."1 In short, the original goal of the Great Experiment that was the founding of the Fed was the preservation of financial stability.
Clearly, this goal failed. Bernanke and the apologists cannot escape this fact: the Great Depression proved this goal was a pipe dream. So have all recessions.
The new institution was intended to relieve such strains by providing an "elastic" currency--that is, by providing liquidity as needed to individual member banks through the discount window; commercial banks, in turn, would then be able to accommodate their customers.
THE FED-MODIFIED GOLD STANDARD
The FED operated under a gold standard. It fought this standard.
As I mentioned, the Federal Reserve pursued this approach to policy in the context of the gold standard. Federal Reserve notes were redeemable in gold on demand, and the Fed was required to maintain a gold reserve equal to 40 percent of outstanding notes. However, contrary to the principles of an idealized gold standard, the Federal Reserve often took actions to prevent inflows and outflows of gold from being fully translated into changes in the domestic money supply. This practice, together with the size of the U.S. economy, gave the Federal Reserve considerable autonomy in monetary policy and, in particular, allowed the Fed to conduct policy according to the real bills doctrine without much hindrance.The policy framework of the Fed's early years has been much criticized in retrospect. Although the gold standard did not appear to have greatly constrained U.S. monetary policy in the years after the Fed's founding, subsequent research has highlighted the extent to which the international gold standard served to destabilize the global economy in the late 1920s and early 1930s.
Academic economists hate the gold standard, weak as it was after 1913.
ACCOUNTABILITY: DINO
What about accountability to the voters? There never has been any, as his brief discussion admits. The system was set up to undermine any accountability.
What about its accountability to the public? As this audience knows, when the Federal Reserve was established, the question of whether it should be a private or a public institution was highly contentious. The compromise solution created a hybrid Federal Reserve System. The System was headed by a governmentally appointed Board, which initially included the Secretary of the Treasury and the Comptroller of the Currency. But the 12 regional Reserve Banks were placed under a mixture of public and private oversight, including board members drawn from the private sector, and they were given considerable scope to make policy decisions that applied to their own Districts. For example, Reserve Banks were permitted to set their own discount rates, subject to a minimum set by the Board.
He said "regional Reserve Banks were placed under a mixture of public and private oversight, including board members drawn from the private sector." What he did not say is "the private sector" was the commercial banking cartel. The regional board members are elected by large banks, which own regional FED shares.
This is classic Bernanke: concealing the relevant facts by means of general words -- "the private sector" -- and footnotes.
The post-Depression FED was governed by the writings of economists.
The policy framework to support this new approach reflected the development of macroeconomic theories--including the work of Knut Wicksell, Irving Fisher, Ralph Hawtrey, Dennis Robertson, and John Maynard Keynes--that laid the foundations for understanding how monetary policy could affect real activity and employment and help reduce cyclical fluctuations.
From now on, keep this list in mind. Fisher was Milton Friedman's favorite economist.
The FED is independent. "It was not until the 1951 Accord with the Treasury that the Federal Reserve began to recover genuine independence in setting monetary policy."
Then came the price inflation of the late 1960s. " However, beginning in the mid-1960s, inflation began a long climb upward, partly because policymakers proved to be too optimistic about the economy's ability to sustain rapid growth without inflation."
He comments:
Two mechanisms might have mitigated the damage from that mistaken optimism. First, a stronger policy response to inflation--more like that observed in the 1950s--certainly would have helped. Second, Fed policymakers could have reacted to continued high readings on inflation by adopting a more realistic assessment of the economy's productive potential. Instead, policymakers chose to emphasize so-called cost-push and structural factors as sources of inflation and saw wage- and price-setting as having become insensitive to economic slack. This perspective, which contrasted sharply with Milton Friedman's famous dictum that "inflation is always and everywhere a monetary phenomenon," led to Fed support for measures such as wage and price controls rather than monetary solutions to address inflation. A further obstacle was the view among many economists that the gains from low inflation did not justify the costs of achieving it.
In summary: the technocrats and economists who set policy did not know what they were doing. But they never do. That's the point. They devise policies to thwart the free market. They fail. These policies backfire, as Austrian economists have maintained ever since Mises' Theory of Money and Credit (1912). He devoted a section of the book to a critique of Fisher.
The consequence of the monetary framework of the 1970s was two bouts of double-digit inflation. Moreover, by the end of the decade, lack of commitment to controlling inflation had clearly resulted in inflation expectations becoming "unanchored," with high estimates of trend inflation embedded in longer-term interest rates.As you know, under the leadership of Chairman Paul Volcker, the Federal Reserve in 1979 fundamentally changed its approach to the issue of ensuring price stability. This change involved an important rethinking on the part of policymakers. By the end of the 1970s, Federal Reserve officials increasingly accepted the view that inflation is a monetary phenomenon, at least in the medium and longer term; they became more alert to the risks of excessive optimism about the economy's potential output; and they placed renewed emphasis on the distinction between real--that is, inflation-adjusted--and nominal interest rates.
So, inflation is a monetary phenomenon. Then what about the tripling of the FED's monetary base since 2008?
Volcker's successful battle against inflation set the stage for the so-called Great Moderation of 1984 to 2007, during which the Fed enjoyed considerable success in achieving both objectives of its dual mandate.
Bernanke took over in February of 2006. He had only two years of "moderation."
Then he praises democracy.
In addition to improving the effectiveness of monetary policy, these developments in communications also enhanced the public accountability of the Federal Reserve. Accountability is, of course, essential for policy independence in a democracy. During this period, economists found considerable evidence that central banks that are afforded policy independence in the pursuit of their mandated objectives deliver better economic outcomes.
But he refused to appear before Ron Paul's committee, and he fought Paul's attempt to audit the FED.
Democracy? DINO: democracy in name only.
Rather, the right conclusion is that, even in (or perhaps, especially in) stable and prosperous times, monetary policymakers and financial regulators should regard safeguarding financial stability to be of equal importance as--indeed, a necessary prerequisite for--maintaining macroeconomic stability.
PERSONAL ECONOMIC INCENTIVES
Don't tell us about "should" without telling us about institutional economic incentives. This is a law of economics: incentives matter. Bernanke has ignored this issue in relation to the FED for his entire career, which was devoted to studying the FED and then running it.
Tripling the monetary base was good policy.
My own view is that the improvements in the monetary policy framework and in monetary policy communication, including, of course, the better management of inflation and the anchoring of inflation expectations, were important reasons for that strong performance. However, we have learned in recent years that while well-managed monetary policy may be necessary for economic stability, it is not sufficient.
MAKING IT UP AS THEY GO ALONG
The FED is still stumbling in the dark.
It has been about six years since the first signs of the financial crisis appeared in the United States, and we are still working to achieve a full recovery from its effects.
He asks: "What lessons should we take for the future from this experience, particularly in the context of a century of Federal Reserve history?" I have a suggestion: We should trust the free market, not the salaried economists at the FED, to set monetary policy.
Today, the Federal Reserve sees its responsibilities for the maintenance of financial stability as coequal with its responsibilities for the management of monetary policy, and we have made substantial institutional changes in recognition of this change in goals. In a sense, we have come full circle, back to the original goal of the Federal Reserve of preventing financial panics.
Don't tell us what "the FED' sees. Tell me about the institutional economic incentives that govern what staff members and senior bureaucrats do. Tell us about rewards and punishments.
He of course praises central bank counterfeiting.
How should a central bank enhance financial stability? One means is by assuming the lender-of-last-resort function that Bagehot understood and described 140 years ago, under which the central bank uses its power to provide liquidity to ease market conditions during periods of panic or incipient panic. The Fed's many liquidity programs played a central role in containing the crisis of 2008 to 2009.
MORE POWER, PLEASE!
But this was not enough. What is needed is more monitoring. This means more FED authority to snoop. This means more controls and more staff members to do the snooping. In short, this means an expansion of FED power.
A senior bureaucrat wants more power. Will wonder never cease?
However, putting out the fire is not enough; it is also important to foster a financial system that is sufficiently resilient to withstand large financial shocks. Toward that end, the Federal Reserve, together with other regulatory agencies and the Financial Stability Oversight Council, is actively engaged in monitoring financial developments and working to strengthen financial institutions and markets. The reliance on stronger regulation is informed by the success of New Deal regulatory reforms, but current reform efforts go even further by working to identify and defuse risks not only to individual firms but to the financial system as a whole, an approach known as macroprudential regulation.
Under his guidance, the economy crashed. So, he demanded more power. He got it. Congress rolled over, as it always does when the FED Chairman asks it to.
The bureaucracy gets more power after the its policies have created a disaster. Are we surprised?
This is DINO in action.
As he admits, they do not know what they are doing.
Financial stability is also linked to monetary policy, though these links are not yet fully understood. Here the Fed's evolving strategy is to make monitoring, supervision, and regulation the first line of defense against systemic risks; to the extent that risks remain, however, the FOMC strives to incorporate these risks in the cost-benefit analysis applied to all monetary policy actions.
Monetary policy is, as they say, "a work in progress." This means: "We make it up as we go along."
TRANSPARENTLY FALSE
He says the FED is more transparent. "We have also continued to increase the transparency of monetary policy." But he fought any audit of the FED by the Government Accountability Office.
Other communication innovations include early publication of the minutes of FOMC meetings and quarterly postmeeting press conferences by the Chairman.
Why not publish the minutes the next day? This is the schedule of Congressional Record.
In particular, the FOMC has released more detailed statements following its meetings that have related the outlook for policy to prospective economic developments and has introduced regular summaries of the individual economic projections of FOMC participants (including for the target federal funds rate).
These press releases are boilerplate copy that is stored in a word processing program. The FOMC simply re-releases it every six weeks. For evidence, see my article on this. It's on Tea Party Economist.
They don't know what they are doing. Here is his conclusion.
In short, the recent crisis has underscored the need both to strengthen our monetary policy and financial stability frameworks and to better integrate the two. We have made progress on both counts, but more needs to be done. In particular, the complementarities among regulatory and supervisory policies (including macroprudential policy), lender-of-last-resort policy, and standard monetary policy are increasingly evident. Both research and experience are needed to help the Fed and other central banks develop comprehensive frameworks that incorporate all of these elements. The broader conclusion is what might be described as the overriding lesson of the Federal Reserve's history: that central banking doctrine and practice are never static. We and other central banks around the world will have to continue to work hard to adapt to events, new ideas, and changes in the economic and financial environment.
Got that? "Central banking doctrine and practice are never static. We and other central banks around the world will have to continue to work hard to adapt to events, new ideas, and changes in the economic and financial environment."
They make it up as they go along.
Here is Bernanke's legacy. It is not over. It has barely begun.
