This is a must-read editorial by Allan Meltzer. Meltzer wrote the book, both books actually, on the history of the Federal Reserve.
Ben Bernanke’s ‘70s Show By Allan Meltzer – WSJ
First some history of Fed policy errors
“In the 1970s, despite rising inflation, members of the Federal Reserve’s policy committee repeatedly chose to lower interest rates to reduce unemployment. Their Phillips Curve models, which charted an inverse relationship between unemployment and inflation, told them that inflation could wait and be addressed at a more opportune time. They were flummoxed when inflation and unemployment rose together throughout the decade…”
“The Phillips Curve often fails to forecast correctly. Spanish inflation has increased in the last year while the unemployment rate rose above 20%. Britain also has rising inflation and rising unemployment. Brazil lowered inflation and unemployment together. There are many other examples if only the Fed would look at them…”
“Throughout its modern history, the Fed has made several of the same policy mistakes repeatedly. Two are prominent now. It concentrates on near-term events over which it has little influence, and neglects the longer-term consequences of its operations. And it interprets its dual mandate as requiring it to direct all of its efforts to reducing unemployment when the unemployment rate rises. It does not have a credible long-term plan to reduce both current unemployment and future inflation…”
Then the policy prescription
“The Fed should make three changes. First, it should increase the short-term interest rate it controls to 1%, which would show that it is aware of the inflation risk and will act promptly to counteract it. Current low interest rates are an opportunity for the Fed to start reducing excess reserves.”
Second, it should announce a specific, detailed plan that explains how it proposes to reduce about $900 billion of the more than $1 trillion banks continue to hold in excess of their legally required reserves.
Third, it should end QE2, its latest round of Treasury bond purchases. If, last November, the Fed had waited two more months before starting QE2, it would have known that a double-dip recession was not about to happen. Instead of waiting, the Fed responded to the cries coming from Wall Street.”
Couldn’t agree more with this
“Current slow growth and high unemployment is not mainly a monetary problem. The financial system has more than ample liquidity. Uncertainty about government policy is a much bigger problem. Businesses have had many reasons to be uncertain, to wait for a clearer outlook that would permit them to more accurately estimate future costs and returns to new investment. Better to hold cash and wait…”
“What we need out of Washington now is spending reduction, lower corporate tax rates, and a three-year moratorium on new regulation. But perhaps most importantly, we need a new Fed policy to prevent 1970s-style inflation. Inflation is coming. Now is the time to head it off…”
Jeremy Jones, CFA
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