If I Were Fed Chairman

The Federal Reserve Open Market Committee doesn’t seem to know what to do.  Just six months ago, it told us it wanted to continue to raise its rate target in 2019.  Only weeks later, it wanted to be “patient” with raising rates.  Now it’s trial ballooning rate cuts.  Its program to get interest rates back to something resembling normal seems to have been aborted before it got even halfway there.  The FOMC needs new ideas.  

If I were in Federal Reserve Chairman Jerome Powell’s shoes, I’d push for gradually widening the target band for fed funds with the idea in mind of phasing it out as the Fed’s main policy tool, to be superseded by quantitative policy. Although quantitative policy is viewed as unconventional, interest rate manipulation has deeply damaged our economy. In any case the Fed has been cutting rates for nearly forty years and the only way to continue that would be to push them below zero, which would be even more damaging.

The fundamental problem is that price signals form the neural network of a free market economy. Interest rates represent the price of credit. We forbid price manipulation in any other area of our economy, but carve out an exception in the case of interest rates. It should come as no surprise then that the credit markets have been susceptible to bubbles and busts.  For instance the dotcom bubble in the nineties, and crises like we saw in 2007–2009. Price fixing in the credit markets cuts off the signaling that would otherwise reign in excesses. It’s the financial equivalent of sticking a penny in the fuse box … you might get the current flowing again, but at the risk of burning down the house.

Not to mention that the “cure” has involved creating even more debt and kiting asset prices, with the result that the wealthy – by definition the owners of most of the assets – have grown much wealthier as the average citizen has been left behind. Judging by its effect on the political landscape, our economy is under greater threat as a result than from any bank failures.

So my new paradigm for monetary policy would involve managing the money supply by buying and selling Treasury securities – quantitative easing and tightening – without setting interest rate targets. In the US system directing the funds created would be a fiscal issue for Congress. The price of credit would be set the same way we insist on for other prices, by the free market.

Imagine you had an unlimited supply of dollars and decided you were going to buy an ETF with the ticker UST, currently trading in a two digit range. You could either specify that you’ll buy ten million shares at whatever the market price is or you could specify that you’ll buy whatever amount the market will offer at $100 a share. One way the quantity is fixed and the price is variable and the other way the price is fixed and the quantity is variable. See the difference? Both are likely to raise the price of UST, but only the second way amounts to price fixing. In the first the market still has price discovery.

The second way is even more aggressive if you publicly announce the price you’re going to buy at, and even more aggressive if you disclose the price you’re going to buy at today, next quarter and next year. This is effectively how Fed funds has evolved since Greenspan started the “transparency” kick. You’re committing potentially infinite funds to your target price and destroy the market. Hence my sticking a penny in the fuse box metaphor.

2 thoughts on “If I Were Fed Chairman

  1. Steve says:

    Well based on Powell’s comments especially his mention of “effective lower bound” some commentators specifically Danielle Dimartino Booth, seems to suggest we’re going to NIRP.
    What a crazy world he lives in especially with comments like “our obligation to the public…” Yada yada yada.
    Do you tend to agree the Fed is inevitably following other central banks down the Nirp and Zirp rabbit hole contrary to your advice?

    “Conference participants discussed new challenges that were emerging after the then-recent victory over the Great Inflation.1 They focused on many questions posed by low inflation and, in particular, on what unconventional tools a central bank might use to support the economy if interest rates fell to what we now call the effective lower bound (ELB). Even though the Bank of Japan was grappling with the ELB as the conference met, the issue seemed remote for the United States. The conference received little coverage in the financial press, but a Reuters wire service story titled “Fed Conference Timing on Inflation Odd, but Useful” emphasized the remoteness of the risk.2 Participants at the conference could not have anticipated that only 10 years later, the world would be engulfed in a deep financial crisis, with unemployment soaring and central banks around the world making extensive use of new strategies, tools, and ways to communicate.

    The next time policy rates hit the ELB—and there will be a next time—it will not be a surprise. We are now well aware of the challenges the ELB presents, and we have the painful experience of the Global Financial Crisis and its aftermath to guide us. Our obligation to the public we serve is to take those measures now that will put us in the best position deal with our next encounter with the ELB. And with the economy growing, unemployment low, and inflation low and stable, this is the right time to engage the public broadly on these topics.”

    1. Bill Terrell says:

      IIRC both Chairs Yellen and Powell have disavowed intentions of using negative interest rate policy, but I do tend to agree that could change. Despite the availability of alternatives the financial establishment seems stuck in its interest rate policy box.

      Even assuming the goal of creating higher inflation had merit, for the Fed to accomplish it without doing anything to interest rates would be child’s play. Money supply can be increased without limit just by giving it away instead of lending it into existence. Why not, it costs nothing to produce. It could be a whole lot more democratic too, say by just cutting a check to every citizen, or handing it over to Treasury for disposition via fiscal policy. This isn’t a recommendation, just to illustrate that there are other ways of creating inflation or mitigating deflation if it’s deemed necessary. That policy makers seem wedded to interest rate manipulation suggests that there must be other objectives behind their actions. One was to wonder whether wealth gap expansion is intentional.

      Look at the 1980s & 1990s. We had much higher interest rates in those decades, a prosperous economy … and … a much narrower wealth gap.

      The notion that centrally imposed low interest rates are necessary for prosperity couldn’t be a more transparent fabrication.

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