The Fed’s Institutional Design

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.

Hayek Lecture by Taylor

John Taylor received the Manhattan Institute’s 2012 Hayek prize for his book, First Principles: Five Keys to Restoring America’s Prosperity.  In the lecture he gave for the occasion, Professor Taylor argued for rules-based policies—-that would be a real reform. The video of the lecture is on the Manhattan Institute site.   It was also published in the WSJ

DeLong, Friedman and Maximal Government

by Chidem Kurdas

The case made for minimal government by Milton and Rose Friedman in their 1979 book, Free to Choose, has been debunked,  according to Berkeley professor Brad DeLong.  Basically, he avers that the Friedman program has been tried and failed. As a commentary on Friedman, this is outrageously misleading. But Mr. DeLong  provides a revealing glimpse of the left-liberal mindset.

Policy Makers and Irrational Exuberance

by Chidem Kurdas

Robert Shiller says the speculative bubble in real estate was driven by “a contagion of optimism” that pushed up prices and expectations in a feed-back loop. This epidemic apparently engulfed regulators as well.  “Government policy makers breathed in the same optimism, which no doubt encouraged them to be lax on regulatory restraint,” he writes in a NYT column.

This is a plausible explanation of the psychological mechanism that operates in any bubble. It eventually collapsed and led to the property slump that underpins the current economic malaise And Professor Shiller is right that public officials are not immune. But federal entities breathing in heady fumes is different from anybody else breathing in the same.

Taylor, Krugman and Quantitative Easing

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?

Rewarding the Punch Provider

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.

Taylor Rule and Fed Witches’ Brew

By Chidem Kurdas

Bubble, bubble, toil and trouble—that’s an apt metaphor for the Federal Reserve policies meticulously dissected by Stanford professor John Taylor, in the Wall Street Journal and other places.  He shows that the Fed set the financial crisis in motion and then made it worse.

Relative to the pattern that held since 1987 – a standard that has come to be known as the Taylor Rule – the Fed kept interest rates exceptionally low in 2002-2006.  Easy credit got real estate prices bubbling, which convinced folks that property prices go only one way and concealed the risk of price declines. Hence homeowners, developers and banks over-extended themselves.

Once the credit bubble collapsed in 2007, the excessive debt became rancid. Taylor argues that the Fed mis-diagnosed the problem as a lack of liquidity. Once again opening the spigot and cutting US rates, it brought down the US dollar. The price of oil, being denominated in dollars, consequently went through the roof. That wrecked household budgets and people responded by curtailing consumption. Thus economic conditions worsened.