Tuesday, November 17, 2009

Is the Fed Going Old School?

In the old days the Federal Reserve never cared about asset bubbles, aside from a Fed chairman like Alan Greenspan warning about "irrational exuberance", not much was done to stop asset bubbles until there was growing price inflation. Then the battle would be joined to fight the inflation with tighter monetary policy, a byproduct was a busting of the asset bubbles. Somehow, of late, talk has turned to the Fed responding to asset bubbles as part of their role. The Fed seems to have realized that they have enough problems to deal with besides taking on asset bubble busting as a specific goal. (Though it will occur anyway in response to Fed tightening.) In a seeming co-ordinated attack, three Fed governors are pushing back against the notion that the Fed should take on as a primary role, asset bubble busting. WSJ's David Wessel reports:
Federal Reserve officials in public mull over a tough issue: Should the Fed raise interest rates to let some air out of a bubble even if there’s not much cause to worry about inflation in prices of goods and services or wages? The old answer was, “No.” The new answer is, well, “Maybe.”

On Monday, in a speech at Northwestern University, the Fed’s vice chairman, Donald Kohn, said the issue needs careful rethinking as a result of the consequences of the housing and credit bubbles. His bottom line: “It seems to me that under most circumstances monetary policy is not the appropriate tool to use to address asset-price developments or growing vulnerabilities in financial markets.” The Fed should use other tools — including its regulatory and supervisory muscle — first. “These tools should be the first that policymakers deploy. From my perspective, central bankers would need convincing evidence that such other tools would be inadequate and that significant asset-price misalignments were developing that would have serious economic costs before attempting to use monetary policy to address them.”

On Tuesday, Janet Yellen, president of the Federal Reserve Bank of San Francisco, tackled similar questions in Hong Kong. Her answer:

“Monetary policy could play a role in restraining undesirable swings in leverage and, by extension, reduce systemic risk. In particular, interest rate cuts in a time of market disruption can be effective at stopping a deleveraging cycle from turning into an uncontrolled crash. And higher rates than called for based on purely macroeconomic conditions may help forestall a potentially damaging buildup of leverage and an asset price boom,” she said. “This raises the broader—and very contentious—issue of whether monetary policy should seek to lean against potentially dangerous swings in asset prices. The answer is far from clear, because the use of monetary policy for these ends necessarily compromises the attainment of other macroeconomic goals. Because such use of monetary policy is costly, high priority should be assigned to developing regulatory tools to address systemic risk. Even so, the crisis of the past two years has prompted many of us to reexamine the widely held view that monetary policy should respond to asset prices only to the extent that they influence the anticipated trajectories of inflation and unemployment. Further research into the connections among monetary policy, the banking and financial sectors, and systemic risk is needed to help answer this question.”

The Chicago Fed’s president, Charles Evans, earlier spoke on the same issue in Paris: “As long as we can’t detect bubbles with great confidence, it seems unwise to adopt fighting them as a policy objective, even if only sparingly.”
Of course, the Fed shouldn't be in the money printing business at all, which is at the heart of price inflation and most asset bubbles. So in one sense, the less the Fed thinks it needs to do the better.

However, Kohn's comments that the Fed should use supervisory and regulatory muscle to control assets may be replacing Feed money policy distortions with a bit of totalitarianism. That is bringing even more of the banking system under government control, and providing another power center for the Goldman Sachs' elitists of the world to attempt to capture.

So the answer to the old school question is no, we are not heading back toward old school. It won't be Alan Greenspan type jawboning. It will be more government regulation and power that will further distort the economy in favor of the power elite..

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