The Fed's Harmful Monetary Policy

From a long-term perspective, the Federal Reserve is doing more harm than good right now to economic stability.

Today’s monetary policy debates sound increasingly like the process of trying to get a picture on the wall centered and straight: “A little more to the left.” “No, that’s not helping, more to the left.” “Yes, that is helping.” “No, that is making it worse, back to the right.”

Depending on your perspective, the picture is either crooked or straight. And when a host of people is noisily debating whether the frame should be tilted left or right, the sound can become downright unhelpful. The same goes for monetary policy.

Yesterday, the Federal Open Market Committee (FOMC) released the minutes from its June meeting, giving financial industry analysts a peek inside what our illustrious leaders at the Federal Reserve are thinking. Unfortunately, there is little agreement as to what the meeting notes mean—there's a near 50/50 split on whether the FOMC’s concerns about a deteriorating economy are proof positive that we’ll see QE3 or some other monetary stimulus program later this year.

QE—or quantitative easing—is a fancy way of saying create money out of thin air to put in a digital bank account and then spend on mortgage-backed securities or government debt in order to lower long-term interest rates. It's kind of like that Libor interest rate scandal you might have read about, except the Fed fixing interest rates is, well, sold as more of a market driven process for setting rates at a non-market established rate.

Beyond disagreement in the perennial guessing game of “What Will Bernanke Do Next?”, there is plenty of debate over whether monetary policy can even influence interest rates any further. Since QE2 and Operation Twist have not moved long-term interest rates much, a third round (fifth round if you could the two “twists”) of monetary stimulus is unlikely to have any additional impact.

Still, even if QE3 could substantively impact the market, there remains the question of whether the weak economy merits more monetary stimulus. For example, unemployment remains high, but it matters whether the problems in the labor market are structural or still remnant of the financial crisis. If unemployment is due to economic immobility, education gaps, and changes in growth sectors of the economy (i.e., more IT workers needed for cloud computing and fewer manufacturing workers needed to operate machinery) then more QE is not the prescription for the economy. If the problem is just that the economy needs a better jumpstart for borrowing to lead to consumption and investments, then leading to hiring, then QE could be warranted (from a neo-Keynesian perspective).

But all of this misses the point in the monetary policy debate.

While the mainstream coverage of the Fed has focused guessing what tie Bernanke will wear when he nexts argues with Rep. Ron Paul (R-Texas) during congressional hearings, or whether there is more room for monetary stimulus to continue aiding the economy, we’ve failed to ask a simple question: Is the current monetary policy paradigm actually helping economic growth?

This sounds like a simple question, and for many commenters in the debate it is a given that monetary stimulus has been a good thing. However, there is a difference between whether monetary stimulus has impacted the markets (clearly it has) and whether this impact has been for the better.

Last month the Bank for International Settlements—based in Basel, Switzerland, and operating as something of a global financial mediator and commenter—released is annual global economic report, with two chapters focusing on warnings for how central banks around the world are actually doing more to destabilize our financial future than helping economic growth.

In what ways are Federal Reserve monetary stimulus policies causing more harm than good?

First, monetary policy is creating a future asset bubble crisis. Consider that cheap money does inspire borrowing, even if not at the levels monetary policymakers would have preferred. Since the start of quantitative easing in 2010, equity prices have steadily grown with investors able to borrow for virtually nothing and take advantage of arbitrage opportunities in a volatile stock market. Commodities like gold, cotton, wheat, heating oil, and coffee are all higher as well, as traders have used cheap money to flood the future markets.

The fears of bubbles are well founded. Consider that unemployment remains high, economic growth stagnant to non-existent, and household debt still sky high. So how is it that the stock market can be 10 percent to 15 percent higher than in 2005 and 2006 at the height of the housing bubble and be seen as in anyway sustainable? And when the Fed does eventually decide to tighten policy from today’s levels this could suck the life out of commodities trades funded not with capital raised in normal markets, but with cheap capital funded by a manipulative Fed.

So when these asset bubbles eventually unwind, it could be very painful. Supporting asset prices masks problems on bank balance sheets, and we could see another example of the subprime crisis as toxic assets are revealed when prices decline.

Essentially we will have responded to the deflation of one bubble (housing) with another. Unfortunately, that would make for a trend. The Fed responded to the dot-com bubble’s bursting with policy that created another bubble, and congressional and regulatory policies channeled this into the housing market. In effect, this is an intentional cycle of boom, bubble, bust. A present crisis is solved by creating a future crisis.

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  • BarryD||

    Hey, what about the Chapman article a few days back, claiming that the whole problem with our economy was that the money supply needs to be inflated more?

  • Hugh Akston||

    Look, it's a well-established fact that without the stimuli and bailouts, the only work that would be available now would be as catamites or as food.

  • BarryD||

    A world that looks like State College, PA!

  • wef||

    In response, central banks in emerging market countries have been buying up dollars and inflating the value of their currencies to remain competitive in the export markets.

    Competitive debasement spreads fiat money inflation over more people worldwide, diluting the desired relative real-wage decrease in the US, which is one goal of the servile central bank. It is likely a mercantilist knee-jerk response, but do not rule out that foreign central bankers might also be motivated to protect the dollar-earning (upper) classes who would otherwise feel the nontradables cost pinch as the local currencies appreciate. In any event, it looks like the dollar recently is not debasing fast enough - but a consolation prize for a (relatively) stronger dollar: it makes deficits easier.

  • Dr. Thaddeus Tingleberry||

    The only people who scare me more than The Bernankes and The Krugmans are those Kool-aid swilling fatheads who think you can plug 5 holes with 4 corks, that you can get 11 marbles out of a can containing 10 marbles, and that **you can save** this bank credit as debt money system requires the perpetual, and virtually exponential making of new loans.

    But because Some of the Dumbest Smart People in the world don't grasp the simple elegance of the inevitable collapse of the dollar, they propose sham solutions which feed into what the Rothschilds and the Bilderberg types understand - major wars are a great way to prop up the economic system and as currencies become scarce or worthless, banks can buy up all sorts of things in The Real World - which is a place many economists and verily, anarcho-libertarians are essentially allergic to.

    The issuing power was, is, and always shall be the thing - even more basic than fiat versus commodity-backed or frac reserve banking. The "issuing power" needs to be restored to The People, to whom it properly belongs.

    But you probably don't really care about anything but calling folks at the Fed poo poo heads...the system itself just is uneluctable, eh?

    Smoke shit instead, mon.

    http://www.lewrockwell.com/roc.....ation.html

  • Voros McCracken||

    Does anyone know if the Bilderberg meetings are any fun?

    If the guest lists are any inidcation, it doesn't sound like it would be...

  • Hugh Akston||

    I imagine that they have to keep the conference rooms uncomfortably hot to prevent the reptile people from going torpid.

  • CPBrown||

    There is never anything wrong with the Fed's monetary policy, until there is.

  • KeithC||

    Probably as good a thread to ask as any. Can someone please explain -- in as simple and basic of terms as possible -- what exactly is the mechanism or logic by which an expansionary monetary policy (i.e. the Scott Sumner perspective) can translate nominal changes in an economy to *real* changes? Is it something along the lines of an aggregate demand narrative -- more money is in the economy, so people start spending it rather than holding onto it because (a) there's more of it, and (b) interest rates are (probably) low, so it doesn't pay to hold onto it? And once the spending picks up, that's that and everything's peachy, as the Central Bank will know exactly the right time to stop printing and/or start pulling money back? I'm guessing the majority of folks here aren't keen on said policy, but even with an econ degree, I find it difficult to make sense of it, and I'd appreciate someone spelling out the explanation that proponents of Sumner would give.

  • wef||

    George Selgin is worth reading.

    http://www.cato-unbound.org/20.....to-sumner/

  • ||

    This sounds like a simple question, and for many commenters in the debate it is a given that monetary stimulus has http://www.ceinturesfr.com/cei.....-c-14.html been a good thing. However, there is a difference between whether monetary stimulus has impacted the markets (clearly it has) and whether this impact has been for the better.

  • brushtom||

    i am always learning new things with your blog this is very good.

  • Libertarius||

    It also doesn't help that feminism was sponsored by the Fed as a means to desoul women and turn them into vessels for the transfer of real wealth from men to the state lolzolzozlz and to give birth to ridalin-addicted neurotic self-hating sons of "single mothers" lolzozlzozlz

    When you unplug from the Fiat Feminism Matrix, you will understand why lefties recoil from gold like a vampire from sunlight lozlzolzlzlloooz the collectivists know their welfare state is built on a tinder pile of paper and the zombies of government schools and the welfare state lolzozlzozllloooooz

  • Hollywood||

    The central bank is itself the biggest cause of the boom and bust.

    Quantitative easing is like adding liquor to the punch bowl at a party that's already out of hand.

    "Man, we should probably go easy for a while, we are gonna pay for this tomorrow, aren't we?"

    Bernanke: "Don't worry about it" *empties more liquor into the punch bowl*

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