Some fascinating news came out the weekend before President Obama’s inauguration, but it was lost in the hoopla of the inauguration. The news related to the transcripts of the Federal Reserve Board’s meetings in 2007, which were released on Friday, January 18, after the traditional five-year wait.
Here are some excerpts from the Reuters article on the transcripts:
“Top policymakers at the Federal Reserve felt for most of 2007 that problems in housing and banking were isolated and unlikely to tear down the U.S. economy as they ultimately did.
Even as crisis signals started flashing red with the freezing of credit markets during the summer, Fed officials believed the troubles would be moderate and short-lived ….”
On August 10, 2007, Tim Geithner, who was then president of the New York Federal Reserve Bank, said, “We have no indication that the major, more diversified institutions are facing any funding pressure." In December of 2007, Ben Bernanke, chairman of the Federal Reserve, said, “I do not expect insolvency or near insolvency among major financial institutions.”
There were other, similar statements in the Reuters report and in an article in The Wall Street Journal the next day*, but I am not going to quote them since my purpose is not to embarrass particular individuals because of they said or didn’t foresee in 2007.
My purpose isn’t even to point the finger at the Federal Reserve as a whole. Rather, I want to look at what the Fed is doing today from the viewpoint of what happened in 2007. My concern is this: If the Fed was having so much trouble figuring out what was happening in 2007 and what to do about it, why should we think they will do all that much better today?
The Fed defends its current policies, i.e., near zero interest rates, constant expansion of the money supply, etc., partly on the grounds that, when conditions change, these policies will be changed: liquidity will be removed from the system when inflation threatens; interest rates will be raised when unemployment is down, etc. But when you see how poorly the Fed understood what was happening in 2007, you wonder why they are going to do a better job of knowing what to do, and when to do it, today.
Also, because Congress and the President were deadlocked throughout most of 2011 and 2012, the Federal Reserve has taken it upon itself to take the lead in not only getting the economy moving but also trying to reduce unemployment. As part of this, the Fed has been doing things it has never done before, such as, as I mentioned before, keeping short-term interest rates near zero for several years, instituting the quantitative easing programs, etc.
I agreed with the Fed when it was doing all kinds of things in the near panic of 2008 and early 2009. The Fed was desperately trying to save the United States, and world, economy from possibly the biggest collapse in over 70 years. But 2013 is not 2008. The economy may not be growing as much as we would like, and unemployment has been too high for too long, but we are not in a panic or near-panic. The Fed does not need to act today like it did in 2008.
What I especially worry about today is that the Fed is trying to do things that it really doesn’t know how to do or that are beyond its competence.** Reading the articles about the Fed’s proceedings in 2007 only increases these worries because the articles clearly show the limitations on what the Fed knows and what it can do. And it seems to me that what the Fed is doing today is going beyond its knowledge and its competence in at least two very important ways.
First, the Fed is trying to use monetary policy (which is the only tool it has) to do things that monetary policy is not designed to do and that may actually be beyond the power of monetary policy.*** For example, the ability of monetary policy to effect unemployment is unclear. It hasn’t done much recently. And when interest rates are already at virtually 0% and the banks have large reserves, it is unclear what more the Fed can do and what effect it will have.
This is a problem because the chances of failing, or of making things worse, increase when you try to do something that is beyond what you normally do. You may not have enough practice to do it right. You may not have enough experience to know how things will work in various situations. Tied in with this, sometimes when you try to do too much, you not only fail at the extra things you are trying to do, but you also can start failing at those things you normally can do.
Second, part of the Fed’s explanation as to why it is okay to keep interest rates near zero while, at the same time, pumping more and more money into the economy, is that the Fed will know when it is time to remove this extra liquidity from the economy so inflation won’t break out. Similarly, the Fed says it will know when to raise interest rates before the economy overheats and some new bubble arises. The Fed promises it can carefully guide the economy and avoid problems by gradually changing policies as conditions change. But then I look at 2007 and see that the Fed couldn’t figure out what was happening, let alone what to do. In fact, fine-tuning the economy was a big part of what Keynesianism was all about in 1960s and into the 70s. What happened as a result of that attempt at fine-tuning? By the mid-70s, stagflation. The problem is that economic prediction is not easy, and fine-tuning an economy is almost impossible. I really worry whether the Federal Reserve has the knowledge and ability to make the kind of precise and incredibly time-sensitive decisions needed to do what it is trying to do.
When a person or a company – or the Federal Reserve – tries to do more than he or she – or it – is capable of doing, when they try to do thing that are beyond their competence, they are setting themselves up for failure. I am very much afraid the Federal Reserve is doing that now.
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*Jon Hilsenrath and Kristina Peterson, “Records Show Fed Wavering in 2007,” The Wall Street Journal, January 19, 2013.
** This is something that I have commented on before. See here and here.
*** The Federal Reserve seems to be succumbing to the old adage: When all you have is a hammer, everything looks like a nail.
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