Monday, May 23, 2011

Federal Reserve, the Mondustrial Authority of the United States

Since the beginning of the financial crisis, it became pretty obvious to me that the Fed had decided to abandon its duties to sound monetary policy so it could use its money printing powers to directly solve the problems of a certain number of large and insolvent banks. John Taylor defines and analyzes these exotic and newly acquired functions of the Fed. He says:
Although some have pointed to an increase in the demand for money or reserves due to flight to quality during the financial crisis, this examination of the dynamics of the Federal Reserve’s balance sheet and other factors shows that it was due to the increase in loans and securities purchased by the Federal Reserve in order to assist specific firms and sectors. ...

But rather than go further in this direction it would be more appropriate for the Federal Reserve to begin to move back to monetary policy rather than what I have called here mondustrial policy. ...

[Nonetheless,] it may be difficult for the Federal Reserve to move in this direction or to exit from its current policy. It is already going down a path to purchase $700 billion more in securities backed by mortgages, credit card debt, student loans, and auto loans. It has stated that these actions are necessary because of the financial crisis. But are there no limits to increasing the size of such purchases in the future? And once the Federal Reserve owns these securities, they will be politically difficult to sell. ...

What justification is there for an independent government agency to engage in such industrial policy?
Taylor also offers evidence that the humongous issuing of bank reserves was the cause of the inordinate fall in monetary multipliers and velocities of circulation seen in the US after the crisis, and not the contrary. As he explains:
But the very severity of the panic in 2008 makes it difficult to convince people that there was not a panic-driven increase in the demand for the monetary base at that time, and I frequently hear economists and economic students sticking to [this] interpretation. ... [However,] the months since the start of QE2 are not even close to the panic observed in the fall of 2008. So it is ... difficult to argue that the Fed was responding to a panic-driven or otherwise autonomous increase in the demand for the monetary base. Much more likely is that — as in the fall of 2008 — banks simply absorbed the increased supply of the monetary base which the Fed used to finance QE2. In fact, if you look at the chart (which goes through April 2011), you can see the same inverse relationship between the money multiplier and the monetary base during QE2 as during 2008--2009

No comments: