Fed needs to be­come less im­por­tant

The Arizona Republic - - Opinions - Robert Robb Reach Robb at [email protected]­zonare­pub­lic.com.

The Fed­eral Re­serve cer­tainly doesn’t suf­fer from a lack of out­side ad­vice. And lately, the ad­vice is tilted to­ward a pause in in­creas­ing in­ter­est rates.

Say­ing that Pres­i­dent Don­ald Trump is of­fer­ing the Fed ad­vice would be sug­ar­coat­ing it. He is loudly protest­ing the in­ter­est-rate hikes that have al­ready been adopted. And, as is his wont, he’s mak­ing it per­sonal, es­sen­tially claim­ing that he was conned into ap­point­ing Jerome Pow­ell as Fed chair­man. Pow­ell, the pres­i­dent com­plains, isn’t the low­in­ter­est-rate guy Trump un­der­stood him to be.

But Trump is hardly alone in the cam­paign for a pause in in­ter­est-rate in­creases. Even the Wall Street Jour­nal, or­di­nar­ily a sup­porter of a strong dol­lar, has ed­i­to­ri­al­ized in fa­vor of a pause, cit­ing a slow­down in for­eign economies and tar­iff un­cer­tainty here at home.

In a mar­ket econ­omy, how­ever, un­cer­tainty is a per­ma­nent con­di­tion. If it’s not tar­iffs, it will be some­thing else. Mar­ket economies are con­stantly in a state of tur­bu­lence, re­act­ing to price sig­nals, in­no­va­tions and shift­ing pref­er­ences.

Un­for­tu­nately, the Fed has be­come a sig­nif­i­cant source of in­sta­bil­ity and un­cer­tainty it­self. That’s not what is de­sired from a cen­tral bank in a mar­ket econ­omy. The Fed needs to make it­self less im­por­tant. It is a long way from achiev­ing that. And the jour­ney is likely to be rocky.

The Fed over­re­acted to the dis­rup­tion of fi­nan­cial mar­kets in 2008, stray­ing far from its tra­di­tional role of en­sur­ing liq­uid­ity in an emer­gency. In­stead, the Fed un­der­took the role of heal­ing the econ­omy through a mas­sive and un­prece­dented mon­e­tary in­ter­ven­tion.

The Fed funds rate was dropped to zero and left there for nearly a decade. The Fed’s bal­ance sheet bal­looned from about $1 tril­lion to $4.5 tril­lion, in an at­tempt to stim­u­late the econ­omy through mon­e­tary ex­pan­sion.

Some of the Fed’s ef­forts to pro­vide liq­uid­ity eased the emer­gency. But this at­tempt to heal the econ­omy through a mas­sive mon­e­tary in­ter­ven­tion pro­duced very lit­tle. The re­cov­ery was slug­gish. The Fed con­sis­tently over­es­ti­mated what the next tranche of mon­e­tary in­ter­ven­tion would pro­duce.

How­ever, the mas­sive in­ter­ven­tion did cre­ate eco­nomic dis­tor­tions that linger to­day. Ar­ti­fi­cially low in­ter­est rates have ar­ti­fi­cially in­creased the price of as­sets, in­clud­ing stocks.

The Fed owns $2.3 tril­lion of debt from the fed­eral gov­ern­ment, act­ing as an en­abler for un­sus­tain­able deficit spend­ing.

The Fed owns $1.7 tril­lion in mort­gage-backed se­cu­ri­ties, ar­ti­fi­cially in­creas­ing home val­ues and re­duc­ing re­turns to fixed-in­come in­vestors.

Ev­ery­one knows that ar­ti­fi­cially low in­ter­est rates have ar­ti­fi­cially in­creased stock prices, but no one knows by how much. That’s why the mar­kets gy­rate with each hint or nod about what the Fed might do next.

There is also a moral di­men­sion to this. The Fed con­sciously screwed small savers and fixed-in­come in­vestors for nearly a decade. It is morally rep­re­hen­si­ble for a cen­tral bank to in­duce peo­ple into riskier in­vest­ments through ar­ti­fi­cially sup­press­ing in­ter­est rates.

The Fed is in no hurry to un­wind this mas­sive, and largely un­pro­duc­tive, mon­e­tary in­ter­ven­tion. The Fed funds rate re­mains well be­low his­tor­i­cal av­er­ages. With re­spect to the bal­ance sheet, the Fed is merely not fully rein­vest­ing all of re­turned prin­ci­pal.

This leisurely pace means that the eco­nomic dis­tor­tions and mis­treat­ment of small savers and fixed-in­come in­vestors will per­sist as well. And that’s not eco­nom­i­cally healthy.

Eco­nomic health is when the value of stocks is de­ter­mined by the eval­u­a­tion of in­vestors about likely fu­ture per­for­mance, not by read­ing the tea leaves of speeches by mem­bers of the Fed’s Open Mar­ket Com­mit­tee. And where the rel­a­tive re­wards of eq­ui­ties and bonds are de­ter­mined by sup­ply and de­mand, not by the de­ci­sion of a hand­ful of cen­tral bankers to go on a buy­ing spree.

The main value of a cen­tral bank is to pre­serve the value of money over time, not to fine-tune the econ­omy from quar­ter to quar­ter.

Fed­eral law gives the Fed the dual ob­jec­tives of full em­ploy­ment and price sta­bil­ity. Para­dox­i­cally, the Fed would do more to achieve them in the long run if it weren’t so hy­per­ac­tive in at­tempt­ing to ma­nip­u­late them in the short run.

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