The Fed’s Fair Share

By Chandrashekar (Chandra) Tamirisa, (On Twitter) @c_tamirisa

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The bespectacled WIN (“Whip Inflation Now”) economic forecaster from New York City, doubted initially by the markets if he could fill in the place of the legendary Paul Volcker at the Fed, had quickly made his presence felt in his first crisis after taking over as the Chairman of the Federal Reserve in 1987: he changed the monetary policy regime of the Federal Reserve by promising the markets in the glare of television cameras that the Fed will standby should the markets fall drastically. It was not clear if the economy would enter into a recession or if the banks that the Fed is charged with supervising would be in any trouble. Alan Greenspan, who had publicly disagreed with Volcker’s tightening, had announced to the world that he was now in charge.

The economic connection between money supply and the various financial market indicators is at best tenuous. The ghost is always the Great Depression. The heuristic response, guided by biased hermeneutics of incomplete information at the time of making decisions in real time, is always to not do what the Fed had done before the onset of the depression: tighten policy. Whether that was a genuine mistake is yet to be determined for reasons that are non-economic, just as it is yet to be determined if FDR should have entered the war at all, even after the surprise attack on Pearl Harbor because neither the Japanese were going to invade the United States nor was Hitler. The political culture does not ask these questions out of political correctness.

So, Alan Greenspan had set out to establish the primacy of the financial markets and the highly time varying eventuality of the trickle down of printed money onto farms and factory floors so as not to even remotely create the conditions for more depressions (and thereby more government). After all, the now octogenarian former Fed Chairman had literally lived through the reign of FDR.

The imaginary specter of depression had thus become a policy tool for the pro-market right, just as it had once also become a policy tool for the Keynesian political left because under FDR when the Fed tightened, the government had expanded fiscal policy to expand. Under Reagan, as the Fed expanded money supply, fiscal policy was being reigned in to curtail government. The political symmetry, similar to lateral inversion, was implicit as the parties fought over power.

Reagan’s politically symmetric act through the Fed had created moral hazard which would mature by 1994 internationally and from 1997-2007, domestically. Alan Greenspan, along with Milton Friedman, was both the advisor and the executor. Reagan’s belief in shredding regulation had made, de facto, monopoly money supply the only regulator of the financial markets. The exuberance of the financial markets was seen as the engine of creative destruction. Bubbles were good.

The Greenspan Fed, however, was rarely wrong on interest rate policy. How can this be possible? After all, whether money supply is directly changed in quantity or changed by targeting a government rate in the so-called federal funds market, it still affects the interest rates. So, if the Fed rate was good, where was all the money coming from even after 1987? The Cold War had ended and foreigners had nowhere to go but to the victor.

The Greenspan Fed’s job was to clean up with rate cuts after the exuberance turned to fear. And the cycle continued through the Clinton administration as Americans went out of their way to consume masochistically to change the world. The Keynesians like consumption and the Schumpetarians investment. Either way it does not matter for Wall Street, similar to lawyers who can argue on both sides to earn a decent living. The radical globalization policies of the Clinton administration had produced consumption at home and investment abroad. On net, the Reagan-Bush conservatives were better: they depended on foreign and defense policies to change the world (as they should) and when needed. It was premature to change the paradigm of international relations to economic competition in lieu of national defense, as early as in 1993, because democracy always precedes open-market capitalism. Otherwise, there is a risk of creating capitalism without democracy. Even Milton Freidman had conceded that before his death.

Alan Greenspan’s discipline to only intervene as bubbles are collapsing by expanding money supply was lost on a Fed, close to the end of his term, which may have been influenced by the European argument to “manage” bubbles with higher interest rates. The European Central Bank, the newly minted transnational institution to administer the euro, had good reasons for contemplating that approach: the Economic and Monetary Union (EMU) of the European Union (EU) is not one country. It is difficult to change regulations in Europe.

This is not the case with the United States. Regulations can be changed to complement monetary policy. But Greenspan, for good reason, did not have faith in the political process to do the right thing at the right time (and he was proven correct more often than not). So, it was best, for him, to engage in moral suasion with the markets urging self-regulation to avert the risks of inflation and speculation each time the Fed intervened. The periodic propping up of the markets was seen as giving the markets the flexibility to learn to become more disciplined. He was, however, wrong on this count because the very same human nature that produces creative destruction on the rise cannot also elevate it to a higher level of responsibility to prevent the fall. Self-regulation is impossible for a large and complex economy such as that of the United States and so is regulation by money supply. Albeit Greenspan’s personal skepticism of government (Reagan’s mantra of “government is the problem”), the government is obligated to oversee effectively where it must. Politics can be changed to both regulate parsimoniously and better. Regulation, not the government provisioning all the goods and services it wants to in competition with the private markets, is the pure public good.

The Bernanke Fed’s current approach since 2003 of raising rates during bubbles also represents a change in policy regime just as Greenspan had changed it to announce his arrival in 1987. The Fed today appears to believe in both raising rates during bubbles and in cutting them when they collapse. The fleeting glimpse of monetary neutrality is similar to that of truth in the modern universe of Heidegger, as the monetary and economic pendula swagger by the mid-point of neutrality between the oscillations of raising and lowering rates. Alan Greenspan had defined monetary neutrality as “we’ll know when we get there,” but it is usually over before we know it. This volatility in economic variables benefits the secondary financial markets because they have learned to bet on both sides of the curve to render their incomes recession-proof and therefore, causing them at will unless they get what they want from the government. Again, the finger points to the failure of government oversight. The collusion of money and power cannot be any worse.

What is necessary is a government that is honest for the financial markets to relearn that their reason for existence is to send the money where it is really needed to innovate where it really matters: to the farms and factory floors as soon as they get it. This is the landscape of Schumpetarian creative destruction.

Bubbles can be good if they are produced in the real world where people live for this is how the world had always worked.


About Chandrashekar (Chandra) Tamirisa
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