Holding the Fed Accountable
By: Dr. Craig Columbus
Many hard questions have been raised in response to the Federal Reserve’s decision to embark on open-ended bond buying or quantitative easing (“QE”). Can we afford it? Will it create jobs? Will the decision undermine the Fed’s long-term credibility? Few have asked, though, is the Fed’s latest move ethical?
Short-term economic gratification is rarely a hard sell. Stock prices have soared in response to repeated Fed intervention. Money printing has also enabled Washington to avoid making hard choices. As a result, there has been little effort on the part of either political party to hold the Fed accountable.
The Fed’s bloated balance sheet has swelled to nearly $3 trillion dollars in just four years, growing by 184 percent since the Lehman bankruptcy, according to The Wall Street Journal. That expansion represents roughly 20 percent of the current U.S. GDP.
Now Mr. Bernanke is back with a pledge of unlimited purchases of residential mortgage backed securities. With the press of a button, unelected Federal Reserve officials can credit banks with more funds and thereby expand the money supply. The move subsidizes large banks (who can “write up” their mortgage backed portfolios) and government-sponsored enterprise (GSEs) like Fannie Mae and Freddie Mac.
The Keynesian-dominated Fed sincerely believes that more QE will lower mortgage rates, further drive up asset prices, make cash appear increasingly unattractive, cause higher-end consumers to feel richer and thus spend more or purchase real estate—ultimately leading to additional demand and more hiring. If home prices rise even marginally, banks will have fewer impaired assets and can ramp up lending.
Others contend QE damages confidence by implying that the American economy is on life support and tells home buyers and business owners that there is no need to act today when rates will remain low for as far as the eye can see. Furthermore, a majority of homeowners have already refinanced their houses following previous Fed actions. Reasonable people can differ about the best approach for fighting deflationary forces.
It is the Fed’s current messaging of unlimited QE, however, that raises ethical concerns. Since the onset of the financial crisis, authorities have behaved as if they do not believe the American people can handle the truth about the state of the financial system and its institutions. By promoting a softer, painless narrative, little public support has developed for deficit reduction and entitlement reform.
Mr. Bernanke frequently pays lip service to the notion that political leaders must also do their part—only to then repeatedly go it alone. The former head of the European Central Bank, Jean-Claude Trichet, even briefly flirted with trying to hold politicians feet to the fire but gave up the reform ghost when markets got too dicey. Central bankers in the United States, Europe and Japan have instead opted for simultaneous currency and debt devaluation strategies via aggressive bond-buying regimes.
But if unlimited QE is worth doing, it is worth defending openly and honestly. The Fed should start by leveling with the American people about the risks of QE to things they consume, particularly in light of stagnant wages. Let’s hope this time Mr. Bernanke will “own” $4 a gallon gasoline. If it comes to pass, he should forcefully make his case for why the benefits to the economy outweigh the pain.
Although oil prices have fallen in recent days, crude typically slides in the months following the summer driving season, and the impact of Fed policy on the real economy is slow-acting. If high gas prices ultimately derail the recovery, Mr. Bernanke should also make it clear that the U.S. budget deficit will require much more immediate action when tax receipts fall.
In addition, an honest defense of QE should describe the techniques being employed to manage Washington’s massive debts. They include a tactic known as financial repression, which forces interest rates to levels below the rate of price inflation. By eroding the value of government debt held by bondholders and savers, politicians can dodge having to convince the public to accept unpopular austerity measures. It does mean, though, that the American people must accept “too big to fail” financial institutions in lieu of hard choices. To maintain unfettered access to the debt markets, the government must backstop primary dealers at all costs.
Some will undoubtedly say that it is naïve to expect the Fed to acknowledge limitations or risks to its unconventional policies. But the financial crisis taught us that unconstrained borrowing and behavior create both costs and unintended consequences. Restoring trust to the financial system requires all participants, including the economic guardians, to engage in full disclosure. Financial markets, politicians, and the American people have all become increasingly dependent on Fed stimulus. However, while dependency is opportunistically captured, trust must be perpetually earned. In this regard, trust, like Mr. Bernanke’s QE, is open-ended.