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The Bank for International Settlements is not saying anything new by pointing out this fear, but it is telling the Fed that it is time to start paying more attention to this concern.
Second, monetary policy is contributing to global economic weakness. Many quality foreign firms have taken advantage of low interest rates, borrowed dollars, and then sold them in their home countries for local currency to fund expansion (essentially betting they will be able to pay back the dollar denominated loans easily and cheaply). The problem is that this increases the supply of dollars in foreign economies and drives up demand for local currencies. Foreign central banks, particularly in emerging market countries (EMCs) have not liked seeing the value of their currencies appreciate because that means fewer companies will be buying their exports (since the cost of goods in countries with stronger currencies is higher). 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.
Essentially, the Fed’s inflationary policy has been transmitted to EMCs. The result has been the stifling of growing middle classes in those countries. Consider Turkey, one of the fastest growing EMCs, which has been favoring its export market by inflating its lira to the detriment of the Turkish middle class. GDP per capita in Turkey nearly doubled from 1999 to 2007 as the country experienced a dramatic economic revolution, but since then has leveled out. Inflation was just 6.3 percent in 2009 but has flirted with the 11 percent range this year.
This is not a class issue, but rather a matter of growing the global consumption base. The weakened purchasing power base of EMCs has contributed to a weakened global economy.
Third, the current monetary policy paradigm has threatened the future of American economic policy integrity as the line between monetary and fiscal policies has become completely blurred. As Atlantic Capital Management President Jeffrey Snider writes, there is nothing really “monetary” about today’s unconventional policies. Buying up bonds and securities to influence long-term interest rates is just borrowing money to create growth, like any other fiscal stimulus program.
The challenge with determining if these are ultimately harms (or evening happening) is that monetary policy is just that—policy making. It involves weighing trade-offs, doing cost/benefit analysis, and making a choice through a particular framework.
If the framework values short-term benefits then the asset bubble harm does not seem like that much of a problem. Much better to help out a few people today and worry about controlling the deflation of commodities and equities prices later. The slow down in emerging market countries is also of limited concern under this view, since low currency values can lead to increased exports as a quick way to boost economic growth. And monetary policy being blurred with fiscal policy is certainly not a concern in a short-term benefit framework since anything would go in order to achieve the objective of attempting to smooth out economic pain.
Contrast this with those taking a long-term benefit view as their framework for assessing the potential harms of today’s monetary policy paradigm. The risk of yet another bubble is terrifying and certainly worth serious consideration. Exports are certainly important for the growth of EMCs, but so is the ability of a local middle class to gain purchasing power and raise GDP-per-capital levels (not just overall economic growth); and that can’t happen with central banks forced to inflate away the value of local currencies. Furthermore, the long-term framework holds in higher esteem the integrity of the Federal Reserve as a monetary body while keeping fiscal policy choices with Congress, creating an inherent knee-jerk reaction against continued stimulus.
So if the FOMC is taking a short-term view (as any body integrated into the political system is wont to do) it is clear why monetary policy has maintained its stimulative levels. Tightening policy could cause credit to contract and possibly slow down an already weak economy. The fact that it could help prevent a steady build-up of misallocated capital is understood, but the benefits of stopping a potential bubble are less than the potential harms of breaking from today’s norms—at least according to today’s leading monetary theorists.
Seemingly lost on the Fed is the irony that this was Greenspan’s logic for ignoring the housing bubble. Back in 2004, economists from the Bank for International Settlements warned about problematic monetary policy creating cheap money that was flowing into U.S. asset markets (particularly housing) and creating a pattern of unsustainable growth. Eight years later we can look back and see how policymakers ignored these warnings and instead lashed out in frustration at that crooked picture on the wall. In 2020 will we look back again and lament Bernanke's current refusal to heed the warnings?
Anthony Randazzo is director of economic research at Reason Foundation and is co-author of "The Hayek Rule: A New Monetary Policy Framework for the 21st Century."