Gunther Schnabl and Thomas Stratmann
Ten years after the outbreak of the global financial crisis, banks in the euro area have not recovered. The Euro Stoxx Financials is 65% below the pre-crisis peak, whereas the S&P Financials has come close to the pre-crisis level. The different fate of financial institutions is due to different monetary and regulatory crisis therapies of the European Central Bank (ECB) and the Fed. Continue reading
by Jerry O’Driscoll
Fed Chairman Jerome Powell testified to the Senate Committee on Banking, Housing, and Urban Affairs. It was the semi-annual testimony mandated by the Humphrey–Hawkins Act. Powell’s testimony was anodyne. He repeated and reiterated the Fed’s planned policy moves with respect to interest rates, and added suitable caveats on economic growth, inflation, and tariffs. Trade policy is a new factor for Fed policymakers. Continue reading
by Jerry O’Driscoll*
The U.S. economy has been growing slowly but steadily since the trough of the Great Recession in June 2009. Deep recessions are typically followed sharp recoveries. Not so this time.
More recently, there is the mystery of low inflation. The Fed’s preferred inflation measure, the core PCE index, has consistently fallen short of its target rate of 2 percent. In July 2017, it came in at a 1.41-percent annual rate. For the Fed, improved growth in employment and the falling unemployment rate should foreshadow a higher inflation rate. The rationale for this is the old Phillips Curve. The reality is that the model is flawed.[1] Continue reading
by Nicolás Cachanosky and Andreas Hoffmann
Even when a policy is successful in achieving its desired ends, we have to consider its unintended and unforeseen consequences, resulting from cumulative market adjustments to policy changes that make it hard to judge the overall outcome of a policy in our complex economy. The Federal Reserve and European Central Bank’s monetary policy responses to the 2008 financial crisis offer two tales of major unintended consequences. This post discusses unintended outcomes of the U.S. Federal Reserve’s crisis policies. In our next post, we address ECB policies.
by Gerald P. O’Driscoll, Jr.[1]
I have been reading Central Bank Governance & Oversight Reform, edited by John H. Cochrane and John B. Taylor. It is a conference volume of unusually high quality with all the discussions of presentations included.
I plan to write more about the book later, but to highlight one chapter here. It goes beyond the usual topics, covered well in the book, on rules versus discretion, credible commitments, policy legislation, and the historical record.
by Jerry O’Driscoll
The issue of banks viewed as too big to fail has been taken up several times on this site. In its Annual Report, the Federal Reserve Bank of Dallas has weighed in on the topic with an essay on “Choosing the Road to Prosperity: Why We Must End Too Big to Fail – Now.”
It is authored by Harvey Rosenblum, the bank’s Director of Research. Since Richard Fisher, the bank’s president, signed off on the annual report, one presumes he endorses the substance of the essay.
It is a very hard-hitting piece, arguing that “the vitality of our capitalist system and the long-run prosperity it produces hang in the balance.” It explains why TBTF is “a perversion of capitalism,” which undermines faith in markets. Rosenblum quotes Allan Meltzer on point: “Capitalism without failure is like religion without sin.”
The essay spares no sacred cows and, among other things, charges that the “the Fed kept interest rates too low for too long” in the 2000s. That directly contradicts the stated position of Fed Chairman Ben Bernanke. I assume there is much grinding of teeth over the essay in Washington, D.C. The essay details how government support is the source of the gigantism in banking today, and debunks the idea that efficiencies and financial innovation are the reason why, since the early 1970s, the share of banking assets belonging to the five largest banks has grown from 17 percent to 52 percent of the total. These financial institutions expand in size to capture the government support available only to the largest banks.
The essay notes that “commercial banks holding roughly one-third of the assets in the banking system did essentially fail, surviving only with extraordinary government assistance.” As noted elsewhere, “a bailout is a failure, just with a different label.” Amazingly, the report even identifies two of the failed institutions – Citigroup and Bank of America (albeit in a footnote).
It’s a lengthy essay and I recommend it to everyone interested in the issue.
Gerald O’Driscoll explains how the Federal Reserve is bailing out European banks. Click for his insightful piece in the Wall Street Journal.
by Mario Rizzo
In today’s Wall Street Journal frequent contributor to ThinkMarkets, Jerry O’Driscoll, has an important opinion piece, “Why the Fed Is Not Independent.”
There has been much discussion recently of the importance of “preserving” Fed independence. But is the Fed independent? Independent of what? Jerry concentrates on the link between the Fed’s monetary policy and the Treasury’s fiscal policy. Consider:
Today, however one parses the term, the Federal Reserve is not now independent. It has voluntarily relinquished the very independence it secured in 1951 by entering into a modern version of the bond support program. That is what the so-called zero interest rate policy amounts to, reinforced by the quantitative easing implemented through QE1 and QE2.
The Fed is committed to holding interest rates at a very low level by purchasing as much Treasury debt as necessary to maintain those interest rates. That is precisely the position the Fed found itself in before the 1951 accord.
Monetary policy once again is not independent of fiscal policy. None of the Fed’s critics can do as much harm to the institution’s independence as it has done to itself.
The whole article is quite interesting. It raises importance questions not only of economics but of politics as well.
by Mario Rizzo
I read with interest Peter A. Diamond’s opinion piece in The New York Times, “When a Nobel Prize Isn’t Enough.” Professor Diamond, by all accounts a very competent economist at MIT, is complaining that he really IS qualified to be a member of the Board of Governors of the Federal Reserve System. He really IS qualified to make decisions about monetary policy. He really IS qualified because he is an expert on labor markets. He really IS qualified because a top priority must be to lower the unemployment rate. And he IS qualified because he knows how to do this.
I might have been forgiven if I had called this blog post, “Peter Diamond is a Crybaby.” Continue reading
by Jerry O’Driscoll
Philadelphia Fed President Charles Plosser gave a major speech on Monday at the Central Bank of Chile. In the polite language of central bankers, the speech constitutes a systematic criticism of not only current Fed policy but of the Fed’s entire response to the financial crisis. Continue reading
by Jerry O’Driscoll
“Prices Soar on Crop Woes” reads the headline in today’s Wall Street Journal.
Global output of key crops such as corn, soybeans and wheat is down, and their prices are up, respectively, 94%, 51% and 80% from June lows. Today’s PPI report has wholesale prices up 1.1% in December after rising 0.8% in November. The Journal reminds us that in 2008 high food prices sparked riots around the world.
Meanwhile Fed officials tell us they don’t expect inflation. It is not an issue of expecting inflation, but of observing it here and now. The Fed prefers, of course, to look at “core” inflation rates, which are much lower. A former Fed colleague explained to me the central bank does so on the theory that people do not need to drive to work and can stop eating.
In our global economy, easy US monetary policy has thus far mainly affected commodity prices (including now food), real-estate in Asia and now broader price measures in Asia. It is implausible that the US would remain unaffected. Food, energy and clothing prices are all rising. I don’t think many households are presently gripped with a fear of deflation.
In the Mises/Hayek theory of economic fluctuations, the transmission of monetary shocks works through producer prices and incomes, and only later consumer prices. No measure of consumer prices, and certainly not a subset of consumer prices, is an adequate gauge of inflation.
by Chidem Kurdas
In two substantial New York Review of Books articles, Paul Krugman and Robin Wells offer their views on various explanations of the property bubble and ways to get out of the slump. On the latter front, they advocate aggressive deficit spending by the federal government and quantitative easing by the Federal Reserve— No surprise to anyone who reads Professor Krugman’s writings.
Regarding the causes of the bubble, they favor the “global savings glut” explanation. This view absolves the Federal Reserve from having spiked the punch bowl at the intertwined credit and real estate parties—by keeping interest rates exceptionally low from 2002 to 2005. It is remarkable that Krugman and Wells dismiss the case against the Fed without even bothering to mention the work that argues and presents evidence for the Fed’s pivotal role in causing the crisis—namely, Stanford professor John Taylor’s book and articles, including a Wall Street Journal piece.
Why does this matter? Continue reading
by Jerry O’Driscoll
In Tuesday’s Wall Street Journal, George Melloan makes the case that savers and investors lose under the Fed’s low-interest policy. He also argues that the policy leads to greater risk-taking by those pursuing yield. Presumably it is leading to the next asset bubble. But where?
by Andreas Hoffmann*
The European Central Bank (ECB) and the Fed differ in many aspects. First, the ECB is considered to be more hawkish on fighting inflationary tendencies. Its primary goal is price stability and it has continued to watch money growth. Output gaps below full-employment are only considered secondary as instrument to forecast inflation.
Secondly the ECB was constructed to be more independent than the Fed. Thus there has been less interaction with fiscal authorities. Less mobility from governments to the ECB (and vice versa) documents this independence. While in the US it is common to see central bank officials and the secretary of treasury plan the future of the economy, in Europe this is not the case. Central bank independence is considered an important aspect of credibility and stability of the currency (the German central bank model). However, the current crisis has made the ECB more “Anglo-Saxon.” Continue reading
by Mario Rizzo
There seems to be broad agreement among economists that the current recovery from the recession will be characterized by a slowly falling unemployment rate. This makes a good deal of sense since the problem that created the recession was a misdirection of resources into a number of sectors including housing construction and the financial industry.
Reallocation of resources takes time. The government is not helping matters in trying to prevent adjustments by various (but not very successful) efforts to slow or reverse the rate of fall in housing prices. It is also difficult for market participants to determine the effect of possible new policies like Obamacare or any further jobs-stimulus legislation. Continue reading
by Thomas McQuade
In looking back over the many excellent posts and comments that have graced ThinkMarkets in its first year, I was struck by the fact that, while many of the literary virtues have been displayed, there has been – surprisingly – nothing that could pass as poetry. I hope to be forgiven the presumption of attempting to rectify that omission with the following submission, vile doggerel though it may be.
I have a tale to tell, O! (A sad, sorry tale, O!) …
It is told in the hope there’s no slipp’ry slope
And that prudence can prevail, O!
Tells the cause of a crisis, cruelly cast
Hitting hard-won savings, thought amassed.
It involves good intentions gone astray,
And the misplaced myth that some experts may
By their brains and their brilliance brave the way
To ensure economic ease, O! Continue reading
by Mario Rizzo
In the course of doing some research about the late economist Charles Kindelberger I came across an obituary article in The Economist dated July 17, 2003. The article made reference to the question whether the Fed’s policies after the then-recent dot com bubble simply saved us from recession or laid the ground for worse to come. It is interesting to read something like this when the current news looks like a replay.
Economists are split over the recent performance of America’s lender of last resort, the Federal Reserve. Some argue that its policy of easy credit inflated the bubble, although nobody can be certain what effect tighter money would have had once the bubble began to expand. Some economists believe that the Fed’s interest-rate cuts since the bubble burst have been a triumph, preventing a severe recession. Others think that the Fed has merely postponed the day of reckoning.
I am sure there are many other articles out there from this period asking the same question. Have any readers found them?
by Jerry O’Driscoll
Yesterday was Cato’s annual monetary conference and Allan Meltzer gave the keynote address. Today at cato.org you can listen to a 7-minute Podcast of an interview with Meltzer summarizing his presentation. He has just completed the last 2 volumes of his history of the Fed.
Meltzer delivers a tough message: no nation that is spending as we are, running deficits as large as we are, along with a loose monetary policy, has escaped inflation. We must cut the deficits by cutting spending. He talks of a $500 billion spending cut. And he offers an innovative approach as to how, using applied Public Choice theory. Continue reading
By Mario Rizzo
I am not happy at the prospect of the Congress making monetary policy. I am also not happy about the Congress making “countercyclical” fiscal policy. But I am really not happy about the extraordinarily poor quality of the arguments being made by economists so desperate to maintain the “independence” of the Fed. The arguments seem to boil down to mentioning what the Fed has done right (or may be construed to have done right) and ignoring the Fed’s role in creating crises in the past.
Who taught these economists how to make an argument?
I expect to say more later. But for now, please check out Jerry O’Driscoll’s post at the Cato blog.
by Jerry O’Driscoll
In an interview with The Wall Street Journal, German Chancellor Merkel called for an end to risky growth policies built on asset bubbles. “In recent years we’ve had the Asian crisis, the new economy crisis, and now this great international financial and economic crisis — we can’t slide into a crisis every five to seven years.” As she notes, however, the central banks of the major economies have implemented “unorthdox” policies to increase borrowing and lending in the current crisis. Those policies risk yet another asset bubble. Continue reading
by Chidem Kurdas
After causing a debacle by flooding the system with oodles of easy money, the Federal Reserve is to morph into the enforcer of systemic prudence. We’re told that Treasury secretary Tim Geithner wants to create a single systemic risk regulator to oversee the whole financial system and the Fed will probably get the job.
Current conventional wisdom holds former chairman Alan Greenspan responsible for the Fed’s mistakes— such as keeping interest exceptionally low in 2002-2006 and not tamping down on excessive lending by banks. That staved off the recession in the aftermath of the stock market collapse, but created the twin credit-property bubbles and the current mess.
ThinkMarkets 