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.

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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."

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • 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.

  • 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.

  • ||

    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.

  • 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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