Arnold Kling  

Interpreting Fed Policy

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1. Ricardo Reis writes,


With regards to its interest-rate policy, the Federal Reserve has followed the advice from theory by committing to …deflation and to keep interest rates at zero for the foreseeable future. It has deviated from the theoretical recommendations by not making a clear commitment to have higher-than-average inflation in the future, and especially by not providing a clear signal that it will keep nominal interest rates low for some time even after the crisis is over.

Scott Sumner might feel a bit less lonely reading this. Thanks to Mark Thoma for the pointer. Reis also tries to explain the Fed's non-standard balance sheet moves.

Rather than try to come up with an economic theory to explain Fed policy, I would suggest a more cynical approach. The goal has been to transfer wealth to banks and to the holders of mortgage securities. The thinking is that those constituents are more important to the economy than taxpayers.

Suppose that in 2013 President Palin meets with Ben Bernanke and says, "I want you to sell your entire portfolio of mortgage securities, by close of business today." I don't think that Bernanke could argue that she was interfering with the conduct of monetary policy.

The Fed has changed from a central bank to a piggy bank. Any economist who tries to interpret Fed policy from the standpoint of economic theory is playing a fool's game.


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CATEGORIES: Monetary Policy



COMMENTS (7 to date)
Bob Murphy writes:

Great post Arnold! Here's what I said when TARP was first voted down:

"The Paulson bailout failed in the House. If it isn't a death blow to the plan, it should be. This is not an economic plan: it is a heist.

It will go down as The Great Bank Robbery of 2008.

The economics behind it are nonsense, but we are naïve if we spend much time even considering the "arguments" for it. This is a money and power grab, pure and simple.
...
Austrian economists tend to be libertarians in their political views, and they are often chided for not keeping these systems hermetically sealed and separated in their minds. Fortunately, this alleged vice is a virtue in our present situation. Because of all the mumbo jumbo thrown around to show why the plan is necessary, some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene. That is a waste of time."

Brian C. writes:

I agree, trying to come up with a theory to explain buying Mortgage Backed securities, is no different than trying to explain the Fed buying stocks or commodities (if banks balances sheet were dominated by theses). I would actually would think that policy would of been more easily explainable because the future value would be a lot more predictable and easier to analyze than mortgage backed securities.

Any explanation trying to show that the Fed is still wholly independent after this type of behavior becomes to convoluted and complex to make it worth anything.

Daniel Kuehn writes:

Quite cynical, but quite possibly true.

"It is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier"

stanfo writes:

[Comment removed pending confirmation of email address and for rudeness. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog.--Econlib Ed.]

guthrie writes:

To be fair, stanfo, it was posed as a hypothetical...!

Doc Merlin writes:

Despite likely being true, your views will be taken as "conspiracy theory" by much of the media if publicized.

:-(

Bill Woolsey writes:

Arnold, you wrote:

"With regards to its interest-rate policy, the Federal Reserve has followed the advice from theory by committing to …deflation and to keep interest rates at zero for the foreseeable future."

It should read, "committing to _fight_ deflation"

P.S. Like most modern monetary theory, this paper is blinded by a focus on interest rate targeting.

It's claim that the quantity of reserves have no impact on inflation is true given the constraint that the federal funds rate is targeted to control inflation. And while changing the interest rate on reserves impacts the demand for reserves and can make just about any quantity of reserves consistent with equilibrium, the notion that keeping the Fed Funds rate and the interest rate on reserves equal allows any quantity of reserves to be consistent with equilibrium is more an artifact of the model that reality.

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