Tuesday, July 21, 2009

What, Me Worry?

. Tuesday, July 21, 2009

Fed Chairman Ben Bernanke published an op-ed in today's WSJ. His message: don't worry, we've got a plan. Daniel McIntosh at DoM is unimpressed:

Gee--is everybody confident now? He goes on to tell how it will be done. A few observations:

1) The chairman of the Federal Reserve Board is worried enough about confidence that he chooses to make this statement.

2) He does so in a form that allows no questioning or rebuttal.

3) To the extent that he discusses the tools to contract the money supply, it's all pretty much the same as before. They aren't nearly as all-powerful as he wants us to believe.

4) Bernanke says almost nothing about the international dimension--including foreign exchange and the impact on what has been the world's reserve currency.

5) All his promises miss the political dimension altogether. Are we really to believe that those who have been personally helped by recent policies--bailed out banks, investment houses, Fannie Mae, Freddie Mac, etc.--are going to sit by and watch the Fed crank up the pain? The relation of Congress and State governments to the stimulus package is similar to that of an addict to cocaine. The American people will want their freebies, and they won't want to pay for them.

I'm supposed to feel more confident after reading this?

I'm not sure how he should feel, but I think McIntosh may be reading this too cynically, and that he is missing some context and subtext. I'll take his points in order:

1. It is possible that Bernanke is "worried enough about confidence" that he published this op-ed at this time. More likely, he published it today to coincide with his semiannual testimony before Congress, which began today (his prepared opening remarks are here). Congress has been talking about "auditing" the Fed, or otherwise demanding a more active role in managing the Fed, largely because of concerns that the Fed has over-extended itself in a way that will prove damaging to taxpayers. Bernanke is defending his actions in advance while attempting to frame the discussion in Congress.

2. See #1. The questions and rebuttals came from Congress today. Further discussion will occur on op-ed pages and blogs.

3. The reason why traditional tools of monetary policy lost traction during the crisis is because the Fed funds rate bumped up against its lower bound (i.e. interest rates cannot go negative). In an inflationary environment this will not be the case, so we have no reason to think that traditional monetary policies will not be effective in reigning in inflation. The question is not whether the Fed can hold inflation down; it's whether the Fed will recognize inflationary pressures early enough to nip inflation in the bud.

4. Bernanke's audience this week is primarily domestic, but that doesn't mean that his op-ed and testimony don't have international implications. Indeed, what would foreign holders of dollar-denominated assets most want to hear? A strong commitment from the Fed to maintain the value of their assets by maintaining the value of the dollar. This is done in part by keeping inflation low. In a sense, then, Bernanke's op-ed offers the most reassurance that he can provide -- in the broadest possible medium -- to international holders of dollars.

5. I find Bernanke's op-ed to be incredibly political. Bernanke is essentially arguing that the Fed can do its job without Congressional interference. This is made more explicit in his opening statement from today:

The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability.

Finally, it should be recognized that this is an op-ed in the WSJ, not a policy paper or beige book. The medium is general, so the language is general.


What, Me Worry?
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