Thursday, September 23, 2010

Gimme Some Truth

. Thursday, September 23, 2010



So a few days ago I posted a somewhat-oblique response to this quip from Felix Salmon:

Which leads me to the conclusion that a lot of what we’re seeing is a lack of genuine independence at the Fed, which became indistinguishable from Treasury during the crisis, and which has yet to break free from Treasury’s grasp.


I suggested that there was one truth, one half-truth, and one non-truth there. The truth is that there is a lack of genuine independence at the Fed, as I discussed here.

The half-truth is that the Fed became indistinguishable from the Treasury during the crisis. It's half-true because the two were often operating in tandem during the crisis, but their core missions and behaviors since the crisis have diverged. Treasury has moved to recoup its "investments" in the financial industry -- and has done a fairly good job at that -- while the Fed has maintained the status quo and perhaps even loosened policy. In other words, Treasury and the Fed have separated because of the different tools at their disposable. Monetary policy moves last, as they say, but it also moves longest. Fiscal policy is good for immediate injections of cash, but almost by definition there is only one or two bullets in that gun. A more sustained monetary effort is needed to help banks repair their balance sheets, increase lending, and reestablish credit lines to get the economy moving again. This process is somewhat long with somewhat variable lags, but it's Fed policy.

The non-truth is that the Fed has yet to break free from the Treasury's grasp. Which institution is more constrained right now, the Fed or Treasury? The Fed gained regulatory authority following the financial crisis, the Fed can increase QE (or not) and Treasury can do little about it, the Fed can set policy reactive to the Treasury. If anything, then, it would be more accurate to say that Treasury is constrained by the Fed than the converse.

At least, that's the way I see it.

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