Misfeasance or Nonfeasance

Dolors & Sense

by Sanford Rose

KISSIMMEE Florida—(Weekly Hubris)—3/28/11—There are two ways in which a central bank can ruin an economy: doing things that are bad and not doing things that are good.

In “The Evil That Good Men Do” (https://weeklyhubris.com/2011/03/21/the-evil-that-good-men-do/) I briefly discussed the first, stepping too long and too hard on the monetary accelerator, basically in 2002 and 2003, for, of course, the most laudable of reasons—preventing a Japanese-style stagnation and revving up a seemingly jobless recovery from the 2001 recession.

The Fed pleads not guilty. It didn’t keep short-term interest rates too low. In fact, it lost control over at least the long end of the interest-rate yield curve for a good part of the last decade because of excess global savings that kept pouring into US Treasuries.

Since global desired savings exceeded global desired investment, the real interest rate (the interest rate minus the rate of inflation) went down. Indeed, it turned negative, making the cost of borrowing painful only to the lender.

But most economists know that virtually every time in history that this has occurred, people borrowed enough to bid up the price of some class of assets to dizzying and unsustainable heights.

So why weren’t the super-economists populating the Fed also aware of this?

And if they couldn’t offset the effects of excess global savings through a less expansive monetary policy, maybe they could have handled the problem by directly curbing the frenetic mortgage borrowing that everyone saw taking place.

Of course, many in the Fed advised just such curbs. The central bank had authority under the Homeownership and Equity Protection Act of 1996 to quash unsafe mortgage lending.

But those who counseled intervention went unheeded. The Fed was indissolubly wedded to the notion of self-correcting financial markets.

The central bank has two jobs: regulating money and thus the price of credit; and supervising, either directly or indirectly, those institutions through which it is funneled. If it didn’t make errors of commission in doing Job # 1, it sure made errors of omission in doing Job # 2.

For that, Congress rewarded it by recently giving it still more authority. Sounds a bit like Gilbert and Sullivan.