Sunday, August 19, 2007

The Folly of Randomness, According to William Poole, President of the Fed Reserve Bank of St. Louis

"I know of no convincing arguments that the Fed could improve productivity and growth by deliberately introducing random disturbances to the economy." (From a Cato article.)

Now there's an interesting statement from someone who belongs to a system (the Federal Reserve) that does nothing but introduce random disturbances to the economy. But if only because he's aware of this, if I had a vote, I'd elect Poole as Fed Chairman. (For the moment, he's Pres and CEO of the St. Louis Fed.)

[Thanks to for the photo.]

Why can't they all see the basic wisdom in this sentence? If only they understood this, we could eliminate much of the instability of world economies.

He goes on thus:

"If that point is accepted, then the converse must also be true—reducing macroeconomic instability improves economic efficiency. Of course, there is an important corollary: If the Fed fails to maintain price stability after achieving it and creating expectations of its permanence, then the disruption to the economy from renewed inflation will be considerable precisely because firms ceased to plan for such an event."

Sound familiar? Like this might be happening as we "speak"?

This is decidedly one of the most important statements I've read in a long time, and it's coming right out of the mouth of one of the members of the very organization I blame for our present difficulties. Amazing.

And he says:

"What should the Fed do when financial instability strikes? In most cases, nothing." Fabulous.

He goes on to defend the Fed's actions with regard to LTCM (see previous post), saying that they intervened just enough--not too much, not too little; and he thinks that the Fed would not have bailed LTCM out, had the private institutions not done so themselves. Hmm. Don't know about that.

Then he says:

"Some observers have viewed the large expansion of hedge funds as a rising danger to financial stability, requiring additional regulation and Fed readiness to intervene. I myself believe the dangers of systemic problems from hedge-fund failures are vastly overrated. The hedge fund industry is indeed large but it is also highly diverse and competitive. Many and perhaps most of the large positions taken by individual firms have other hedge funds on the opposite side of the transactions. I trust normal market mechanisms to handle any problems that might arise."

We'll see, won't we? I hope to goodness he's right.

He also says:

"The Fed has a responsibility above all to maintain price stability and general macroeconomic stability to reduce the likelihood of economic conditions that would be conducive to financial instability. Included in this responsibility is provision of advice to Congress on needed legislative action to deal with possible risks. The largest of these risks on my radar screen arises from the thin capital positions maintained by government sponsored enterprises and the ambiguity of whether Congress would or would not act to bail out a troubled firm. The time to deal with potential financial instability caused by structural weaknesses of the GSEs and their regulatory regime is before instability strikes."

Well, they may have to deal with these issues after the fact. Again, we'll see.

To go back to my original point about macroeconomic stability, I'll quote another, Friedrich A. Hayek, in The Road to Serfdom: "If the individuals are to be able to use their knowledge effectively in making plans, they must be able to predict actions of the state which may affect their plans."

'Nuff said.

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Anonymous Anonymous said...

Unfortunately, I think I read that Bill Poole is set to retire next year.

12:49 PM  

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