Saturday, January 20, 2007

The Fed: A Case of the Blind Leading the Blind

Typical hubris of the high and mighty. Federal Reserve Governor Frederic S. Mishkin gave a speech on Wednesday that reveals a lot about the way the Fed thinks.

The Blind Leading the Blind
[Thanks to and artist Linda Prokop for the picture.]

Basically, what he says is that housing price bubbles don't really matter, that the central bank can take appropriate palliative action when the time comes, and that asset bubbles should not be regarded as important. He speaks as if housing price increases have no consequences, ignoring the proverbial widow on a fixed income whose property taxes double in the space of five years and who is forced out of her home.

Who is he to say that this poor woman's fate doesn't matter? I am disgusted.

His speech leaves out one important point about bubbles: Their cause. For some reason, the US Fed and a few other central banks want to deny (1) the classic economic theory that states that this type of price increase is caused by an excess of purchasing media chasing after too few goods (read assets); (2) that just because the general price level has remained relatively constant while these asset bubbles are occurring does not exclude the possibility that there is an excess of liquidity in circulation causing those bubbles; and (3) that the Fed and other central banks around the world have brought about this excess through their bouts of overly loose monetary policy.

I will quote excerpts from his speech in which he defends the US decision to disregard asset bubbles in determining monetary policy, even though the rest of the world with few exceptions is very much preoccupied with actively combatting this problem through monetary policy adjustments (with my comments):

"[Taking asset prices into account] in the conduct of monetary policy requires three key assumptions. First, one must assume that a central bank can identify a bubble in progress. I find this assumption highly dubious because it is hard to believe that the central bank has such an informational advantage over private markets. Indeed, the view that government officials know better than the markets has been proved wrong over and over again. If the central bank has no informational advantage, and if it knows that a bubble has developed, the market will know this too, and the bubble will burst. Thus, any bubble that could be identified with certainty by the central bank would be unlikely ever to develop much further."

(But the markets do identify these bubbles. If the Fed can't see the bubble in global housing prices, Governor Mishkin, you all should get some glasses. Every other country in the world sees it and most are taking action against it.)

"A second assumption needed to justify a special role for asset prices is that monetary policy cannot appropriately deal with the consequences of a burst bubble, and so preemptive actions against a bubble are needed."

(This means that you believe monetary policy CAN deal appropriately with those consequences through the further creation of purchasing media -- the old Keynesian push-the-string method that we all know doesn't work and that actually created the problem in the first place.)

"[T]he bursting of asset price bubbles often does not lead to financial instability.... House prices are far less volatile than stock prices, outright declines after a run-up are not the norm, and declines that do occur are typically relatively small.... In the absence of financial instability, monetary policy should be effective in countering the effects of a burst bubble."

(So, I guess that makes them okay. Who cares about that little old widow's property tax increases? Not Governor Mishkin, obviously.)

"Many have learned the wrong lesson from the Japanese experience. The problem in Japan was not so much the bursting of the bubble but rather the policies that followed. The problems in Japan's banking sector were not resolved, so they continued to get worse well after the bubble had burst. In addition, with the benefit of hindsight, it seems clear that the Bank of Japan did not ease monetary policy sufficiently or rapidly enough in the aftermath of the crisis..... A lesson that I draw from Japan's experience is that the serious mistake for a central bank that is confronting a bubble is not failing to stop it but rather failing to respond fast enough after it has burst. "

(Whatever happened to refraining from creating it in the first place? You say the Japanese didn't push-the-string hard enough? They seem to agree with you, because they still haven't stopped trying this impotent trick, and their stagnating economy shows it.)

"A third assumption needed to justify a special focus on asset prices in the conduct of monetary policy is that a central bank actually knows the appropriate monetary policy to deflate a bubble."

(How modest this sounds, yet it is just amazing that at no time does the Governor consider the possibility that the Fed might not know the effect of the loose monetary policy that probably caused the increased asset prices in the first place. Why is it that this lack of knowledge doesn't prevent them from doing it anyway? I can't believe the two-faced arrogance.)

"However, there is a further reason why I believe that a central bank should not put too much focus on asset prices. Such a focus can weaken its public support, making it harder for it to successfully conduct monetary policy to stabilize inflation and employment.... A central bank that focuses intently on asset prices looks as if it is trying to control too many elements of the economy.... A central bank that expanded its focus to asset prices could potentially weaken its public support and may even cause the public to worry that it is too powerful and has undue influence over all aspects of the economy.... Too much focus on asset prices might also weaken support for a central bank by leading to public confusion about its objectives."

(Now we get down to the nitty-gritty. He is afraid of losing his power and his position. Strangely enough, he doesn't realize that some of us already know the Fed is too powerful and has undue influence over all aspects of the economy, and we want nothing better than to see the Fed's role narrowed to privatized supervisor of the banks and defender of the consumer such as our poor widow.)


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