What would you do if you were confirmed as Chairman of the Federal Reserve?
It’s easy to be a critic. And anyone that knows me knows I’ve never been one to shy away from easy. But what if I were actually in the hot seat, and had both the power and responsibility of doing my best for the American people? There’s not much danger of that happening, but if it did, this would be my five point program.
First, I would decouple the fed funds target and quantitative easing. Specifically, I would allow the fed funds rate to begin to rise while continuing QE at its current level. The Fed has been missing opportunities to get the fed funds rate off the floor because of a dogma that holds QE is only a secondary tool appropriate only when the fed funds rate is bottomed out. This artificial constraint would be the first to go.
Second, I would promptly phase out the purchasing of mortgage backed securities. Quantitative policy would include only buying and selling of the purely monetary assets of Treasuries and gold.
Third, I would gradually broaden out the fed funds target band – currently 25 basis points – the target rate would rise by moving the upper bound. This would gradually lead to there being no effective interest rate target … monetary policy would be conducted solely through quantitative policy … buying and selling Treasuries and gold.
Interest rates represent the price of credit, and price fixing doesn’t work any better in the credit market than in others. To the contrary, under interest rate targeting all our biggest financial problems have all involved credit, from the financial crisis of 2008 to exploding debt. Price signals form the neural network of the financial system, and jamming them is the financial equivalent of sticking a penny in the fuse box. You might get the juice flowing again, but at the risk of burning down the house.
Fourth, I would end “forward guidance” as a policy tool. It’s not possible to know what monetary policy will be appropriate next week, let alone years in advance. I would drop the pretense and acknowledge that data dependence is all that can be honestly promised.
Fifth, I would abandon the 2% inflation target. The whole idea was marketed as a sort of margin of safety to keep a distance from the supposedly far more damaging deflation. In other words, sort of a slippery slope theory of deflation. It assumes that deflation is the result of inflation slipping too low.
But the real world doesn’t obey. The most serious bout of deflation in modern memory was born in an inflationary surge that saw home prices bubble and crude oil soar to $147 a barrel … in July of 2008 … mere weeks before a deflationary collapse that saw the giant federal housing agencies taken into conservatorship on September 6 and Lehman Bros implode on September 15. It is inflation that sows the seeds of deflation. That which deflates must first have been inflated.
And how has the 2% business worked out? Since the target has been in place, inflation has ranged from below zero to nearly 15% … nearly 6% even by government numbers. When something doesn’t work, don’t do it.