Federal Reserve

Oh, The Irony

In case you needed any more evidence that top policymakers are divorced both from reality and from understanding the consequences of their actions, witness Federal Reserve Board Vice Chairman Stanley Fischer’s interview today, in which he stated that “we had a financial crisis which was caused by behavior in the banking and other parts of the financial system and it did enormous damage to this economy.” Sorry, but it wasn’t bad actors in the banking system that caused the financial crisis. The Federal Reserve System was pumping money into the economy as fast as it could, pushing interest rates too low for too long and encouraging excessive risk-taking. Government housing policies were pushing for higher and higher homeownership rates, spurring lenders to reduce their lending standards to meet the government’s targets. And then once the crisis hit the Fed and the federal government tried to wipe their hands of the whole mess and blame everything on a few bad actors. That’s why Dodd-Frank and the whole mess of post-crisis regulations that have come down the pike completely missed the mark. Not only WILL they do nothing to stop a future crisis, they CAN do nothing to stop a future crisis because they misdiagnosed the cause. Dodd-Frank was just an attempt to use the crisis to force through a bevy of legislation that otherwise would have floundered in Congress for years. The worst part of it is that even after everyone will have realized that the bill was a complete flop, it will remain on the books for decades.

Rules for International Monetary Stability

The Hoover Institution’s DC office held a short event this morning on “Rules for International Monetary Stability” which highlighted papers from last year’s Hoover Institution Monetary Policy Conference. While much of the discussion devolved into the minutiae of the particular monetary rules that “should” be implemented, there was one thing that stuck out to me that didn’t seem to be picked up on either by the audience or by the presenters. Professor Michael Bordo, in his presentation on monetary policy rules mentioned on several occasions how well the international gold standard worked as a monetary policy rule from 1880 to 1914. However, he also stated that it “stopped working” after World War I.

But as George Selgin and others have pointed out, not only did it work well, it didn’t just “stop working” – it was done away with by governments the world over. The gold standard was a hindrance to government spending, so governments around the world decided to jettison it. That was not a fault of the gold standard, it was a feature, keeping governments from being able to print money ad infinitum. Once governments got off gold, all sorts of mischief ensued – bank holidays, successive devaluations, hyperinflation, etc. I was tempted to ask the presenters: “If the gold standard worked so well, why not use that as the monetary policy rule going forward?” You can hear the scoffing now, and the protestations that the gold standard is impractical and that’s why it was abandoned. But in reality, the gold standard is no different than the Taylor Rule or any other monetary policy rule – once it begins to handcuff the government’s ability to inflate its way out of a recession it will be discarded. Fiscal dominance will always win out.

At the end of the day, discussions about central bank independence are moot. The success of any monetary policy rule, or indeed any monetary policy, is dependent on the government’s AND the central bank’s willingness to voluntarily set very limited boundaries for its own actions and to adhere to those boundaries. Once those boundaries have been crossed, the credibility of the government or the central bank to withdraw and retrench within those boundaries is gone. That’s what we face today. Central banks that have engaged in relentless quantitative easing, credit accommodation, and experimental negative interest rate policies cannot be trusted to return even to a pre-crisis monetary policy stance, let alone anything resembling a stable monetary policy rule.

First Quarter: Temporary Slide or Precursor to the Plunge?

Fed Vice Chairman Stanley Fischer today said that weak growth in the US economy in the first quarter is likely only temporary, and that the Fed could continue on with its planned rate hikes. Time will tell whether he’s right or wrong, but there is so much evidence out there that the economy is dependent on central bank money printing for its continued health that we can’t help but think that Fischer really isn’t in tune with what’s going on. Once the central bank stock and bond purchases wind down, stock markets will lose their luster, markets will begin to panic, and in the absence of any further quantitative easing the malinvestments that have been propagated through a decade of easy money will eventually be brought to light. Fischer, like most economists of the past few decades, doesn’t understand the consequences of his actions because of his failure to believe the teachings of Austrian Business Cycle Theory. That disbelief is irrelevant, however, and the consequences of the Fed’s decisions will occur regardless. When they do, let this post be a reminder that the Vice Chairman of the most powerful central bank in the world didn’t see the crisis coming.

Personnel Is Policy: Who Donald Trump Could Appoint To The Fed

There is perhaps no better way of summing up the direction of any organization than the phrase: “Personnel is policy.” With regard to government, that means that the people who are put into positions of power indicate the direction of actual policy more clearly than the President’s statements. President Ronald Reagan’s tenure was a good example of this. Despite his many public statements in favor of gold, his appointments to key positions and in particular to the Gold Commission were people who undermined his publicly-stated positions. Whether he was aware of this or not is up for debate, especially as we now know of his battle with Alzheimer’s.

That is the danger that might face the current Trump Administration where, despite his many public statements favorable to the gold standard, President Trump may end up appointing officials who hold exactly the opposite view as he does. This is particularly important now that news outlets have been reporting this week that President Trump is set to appoint Randal Quarles to the Federal Reserve Board as Vice Chairman of Regulation. Mr. Quarles’ biography is as establishment as it comes. He received his A.B. from Columbia University and his J.D. from Yale Law School. He worked at the Carlyle Group, a leading private equity firm whose close political connections to former senior Administration officials are legendary. His wife is Hope Eccles, grand-niece of Marriner Eccles, the Federal Reserve Board’s Chairman from 1934-1948, after whom the Fed’s headquarters building is named. Mr. Quarles also served as Under Secretary of the US Treasury, Assistant Secretary of the Treasury for International Affairs, US Executive Director of the IMF, US Executive Director of the European Bank for Reconstruction and Development, etc. Doesn’t exactly sound like a guy who is about to shake things up, right?

While his nomination isn’t official yet, let’s look at some other possible candidates President Trump might appoint to the Federal Reserve’s Board of Governors. We’ve split them into four categories.

1. The Dream Team – those candidates who would be the best possible from the perspective of those of us favoring sound monetary policy.

2. Establishment Favorites – the favorite candidates of the Establishment, or those already under consideration by the Administration.

3. The Compromise Candidates – these candidates are all former Presidents of regional Federal Reserve Banks. While they wouldn’t be the first choices of either the Establishment or of advocates of sound monetary policy, sending former regional Fed Presidents to serve on the Board might send a message to the Board to take into account not just the views of the Washington/New York financial-political elites.

4. The Dark Horses – while perfectly qualified for serving on the Board, these candidates are probably not as well known to the general public, and even to most policymakers, as some of the others.

Remember, President Trump will have at least four appointments to make in his first term, maybe even five if Chairman Yellen resigns her seat after her chairmanship is up, so his decisions on appointments could have a strong impact on the conduct of monetary policy going forward.

Donald Trump and the Federal Reserve’s Board of Governors

With the announcement earlier this week that Federal Reserve Board of Governors member Daniel Tarullo will resign effective April 5, 2017, the Federal Open Market Committee (FOMC) will likely find itself in a highly unusual situation come April, one in which the regional Federal Reserve Bank Presidents on the FOMC outnumber the members of the Board of Governors. The Board of Governors of the Federal Reserve System has been operating with two vacancies for several years, following the resignations of Jeremy Stein and Sarah Bloom Raskin in 2014, and Tarullo’s resignation will bring that to three open positions.

Let’s recall the structure of the Fed’s Board of Governors. Each of the seven governors is appointed to a 14-year term, with each term beginning on February 1st in an even-numbered year every two years and expiring 14 years later on January 31st. So a new term began on February 1, 2016, another will begin on February 1, 2018, another on February 1, 2020, etc. The two current open terms are the one that began in 2016 and the one that will begin in 2018. Tarullo’s term expires January 31, 2022. A governor appointed to a full term may not be reappointed, but a governor appointed to fill the remainder of an unexpired term may be reappointed for another full term.

The two current openings mean that President Trump could appoint someone to the current unexpired term that expires January 31, 2018, then reappoint that person to a full term that expires January 31, 2032. He could also appoint someone to the unexpired term that began February 1, 2016 that expires January 31, 2030, and that person could then be reappointed in 2030 until 2044. With Tarullo’s resignation, he could appoint someone to fill that unexpired term and, if he wins re-election in 2020, reappoint that person to serve until 2036. Finally, Vice Chairman Stanley Fischer’s term expires January 31, 2020, giving President Trump a fourth appointment opportunity until 2034. And, since Chairman Janet Yellen’s term as chairman expires in 2018 (her Board position expires in 2024), President Trump will also get to pick a new chairman next year.

January 8, 1912: Report of the National Monetary Commission

On January 8, 1912 the National Monetary Commission established by the Aldrich-Vreeland Act issued its final report. The Aldrich-Vreeland Act had been passed in 1908 in response to the Panic of 1907. The act established a monetary commission that studied the banking systems of England, France, Germany, Switzerland, Canada, and other countries, and issued a series of documents during its existence. The Commission’s final report contained suggestions for a National Reserve Association to further nationalize the banking system, centralize reserves, and respond to combat financial panics. The ideas and language in that final report formed the basis for the eventual creation of the Federal Reserve System. Some advocates of sound money have advocated the creation of a new monetary commission, the Centennial Monetary Commission, which would examine the Federal Reserve’s performance over the past century and put forth proposals for a potential overhaul of the American financial system.

Anniversary of Murray Rothbard’s Death

Today is the anniversary of the death of Austrian School economist Murray Rothbard in 1995. Along with Ludwig von Mises and others, Rothbard was one of the men most responsible for popularizing the Austrian School of Economics in the United States. Following in the vein of Carl Menger, the founder of the Austrian School, Rothbard made important contributions to economics as well as economic and monetary history, and gave penetrating insights into the public policy impacts of monetary policy. For those wishing to begin reading Rothbard’s work on money and banking, his short book “What Has Government Done to Our Money?” and the longer “The Mystery of Banking” are great introductions to and explanations of the workings of the American banking and monetary system.

Takeaways From The FOMC Meeting

As expected, the Federal Open Market Committee (FOMC) raised its target federal funds rate to 0.50-0.75%. There wasn’t much substantive change in the language of the statement. Economic activity was judged to be expanding at a moderate pace, with a declining unemployment rate. Measures of inflation were said to have “moved up considerably” but still remain low, which seems to be contradictory. All FOMC members voted in favor of raising the target federal funds rate at this meeting.

Looking forward to 2017, some media reports have touted that the Fed’s “dot plots” point to the potential for three rate hikes in 2017. That possibility has a few things working against it. First, the Fed is watching closely to see what other central banks are doing. If the European Central Bank, Bank of England, and Bank of Japan maintain loose monetary policy, the Fed will find it tough to raise rates unilaterally. Secondly, the FOMC membership is switching up again as it does every year. For those who are unfamiliar, here’s the Federal Reserve’s description of the FOMC:

The Federal Open Market Committee (FOMC) consists of twelve members–the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options.

Next year the four Federal Reserve Bank Presidents rotating onto the FOMC are: Charles Evans of Chicago, who has a dovish reputation; and Patrick Harker of Philadelphia, Robert Kaplan of Dallas, and Neel Kashkari of Minneapolis, all of whom are recently-hired and will be voting on the FOMC for the first time. Dallas and Philadelphia have reputations for being more hawkish, but it remains to be seen whether the new Presidents will maintain that reputation.

What the Federal Reserve Will Do This Week

Just about everyone expects the Federal Open Market Committee (FOMC) to raise its target interest rate at its meeting this week. The talk of raising rates has occupied newspaper columns all year, and the comments from FOMC participants have become stronger in recent months in discussing their desire to raise rates. But the decision to raise rates won’t have come about because of any strong economic data, be it inflation hovering around the Fed’s target or the low unemployment rate showing strength in the labor market. Labor market activity has been relatively steady all year and there haven’t been any surprisingly strong signs of economic growth, so why the green light now? Because the European Central Bank (ECB) announced at its meeting last week that it would extend but taper its bond purchases.

In the aftermath of the financial crisis, one central bank after another engaged in quantitative easing. The Federal Reserve, Bank of England, ECB, and Bank of Japan all engaged in large-scale asset purchases in attempts to drive down interest rates, remove overvalued assets from bank balance sheets, and attempt to jump-start their economies. Various interest rate targets were driven to near-zero, and even negative in Japan and Europe. Central bankers eventually realized that they couldn’t maintain those levels of policy accommodation indefinitely. But no one wanted to be the first one to start tightening. The fear was that if a central bank began to tighten policy while other central banks didn’t, the first country’s tighter policies would cause its economy to slow down, harming its relative position vis-a-vis other major countries. No central bank wanted to take the blame for weakening its country’s economy. So month after month, meeting after meeting, central banks just held pat.