On Tuesday, the Subcommittee on Monetary Policy and Trade of the House Financial Services Committee, chaired by Rep. John Campbell, R-Calif., continued the discussion of the merits of the policy of the Federal Reserve to maintain extraordinarily accommodative policy for a further period until the unemployment rate declines to 6.5 percent with modest inflation. An outstanding panel of experts in monetary policy testified at the hearing.
In his opening statement, Campbell said the purpose of the hearing would be to take a closer look at the costs and benefits of the policy following last week’s hearing
and to consider when it might be appropriate to bring the policy to an end.
The ranking Democrat on the Subcommittee, Rep. William Clay, D-Mo., read a statement that sounded like it was written by the Fed, repeating the language of Chairman Ben Bernanke explaining the Fed’s stance as to how it plans to pursue quantitative easing (QE). In this instance, it was useful to get this on the table, but it is another example of the Fed and supporters of the administration seeing their interests aligned. In the long run it raises questions about the so-called “independence” of the Fed from the influence of short-term political interests.
To assist in its inquiry, the Subcommittee was fortunate to have an excellent panel of expert witnesses. David Malpass is a former Treasury official who runs a private investment business, which gives him a good vantage point to talk about the reactions of investors to Fed policy.
Allan Meltzer, an economics professor at Carnegie Mellon for over 50 years and former chair of the Shadow Open Market Committee, took up the task of compiling the history of monetary policy from the great economists Milton Friedman and Anna Schwartz, while John Taylor, an economics professor at Stanford, has been the leading proponent of the so-called “Taylor rule,” which seeks to provide a guide for Fed policy that can reduce market uncertainty and improve the prospects for the Fed to achieve its goals.
Finally, Joseph Gagnon, a senior fellow at the liberal Peterson Institute for International Economics, represented the view of Democrats that if anything, the Fed should have been more aggressive three years ago, and he expressed satisfaction that the Fed seems finally to have come around to his view.
The reason there were three conservatives and one liberal on the panel reflects the fact that the Republicans control the House. When the Democrats are in charge, the balance of the panels is reversed, but the rules call for the minority to have the opportunity to provide a witness.
In their statements, Malpass charged that the Fed’s policies are responsible for the rate of gross domestic product growth of 1.6 percent, well below earlier Fed projections of at least 3.5 percent. Meltzer complained that Fed policy has enabled the government and banks to borrow cheaply at the expense of households, and he noted that the result has been an increase in the prices of farmland and stocks (a new high was hit for the Dow Jones Industrial Average today).
He predicted that the policy would end “in tears” as the aftereffects take hold in the form of inflation, recession and higher interest rates. Meltzer advocated adoption of a rule like the Taylor rule to constrain the exercise of arbitrary power by the Fed and restore the constitutional role of Congress in establishing the policy the monetary authority should follow.
Taylor traced the 2008 episode of the financial crisis back to an overly expansive monetary policy the Fed followed from 2003 through 2005. Thus, the policy the Fed is following is justified as a cure for earlier errors. He concluded that the costs are now greater than the benefits, and he expressed the hope that the economy will improve enough for the Fed to unwind the policy.
Gagnon disagreed with the other panelists and called for an even more expansive policy. He also asserted that the right interests are benefiting from QE and that fears that the Fed risks losing huge amounts of money whenever the policy is unwound are hypothetical and unwarranted.
In watching the hearing, I was reminded of the classic book by Henry Hazlitt, Economics in One Lesson: The Shortest and Surest Way to Understand Basic Economics. The lesson is that in making economic choices, it is necessary to consider all of the effects.
Thus, when the Fed states that it is lowering interest rates in order to encourage investors to take more risk, it tends not to consider the side effects and the longer-term effects of its policies as monetary policy works its way through the economy.
Also, the conservative panelists expressed concern about the ability of the Fed arbitrarily to favor some asset classes and investors over others. Now that the stock market has reached a nominal new high, I wonder what the authorities might feel compelled to do in order to defend the stock market against an ugly reaction that might be built into the asset bubble they have created in order to “simulate” the economy.
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