The Case For Structural Monetary Intervention

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

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Federal Reserve Chairman Benjamin Bernanke is a new orthodox. In it he differs from Marriner Eccles, the old orthodox, who believed during his tenure at the United States Treasury and the Federal Reserve that excess money causes unsustainable stock prices and, therefore, withdrawal of money could stabilize pre-October 1929 downturn of the market. That decision had made the problem worse.

Bernanke, however, is making another consequential mistake once again in the nearly 100-year old history of the institution he runs despite doing the right thing by keeping the money spigots wide open – a trait of the new orthodox in monetary economics since Milton Friedman: he is hands-off.

The Federal Reserve sees its role as safeguarding the capacity of private financial institutions such as commercial banks, and of financial holding companies (FHCs) since the 1999 Gramm-Leach-Bliley removal of the Glass-Steagall firewall between commercial banking and other financial institutional functions.

Fed provides fresh money off the presses – through money and bond markets, and other markets for more complex financial instruments such as derivatives – to financial institutions on Wall Street when they are in systemic crisis (more than one institution failing at the same time leading to real economic consequences) for the markets to do their job to recover the US economy.

In the global economy, where the US dollar is pervasive, such a hands-off approach in severe crises may not always first benefit the domestic economy. Sufficient data exists since 2007 and so do explanations for why the economy has recovered and then declined twice.

The Fed Chairman has been on record after 2007 that his agency will not engage in industrial policy. Yet, he obliquely did by aiding Wall Street financial institutional consolidation picking winner and losers and through the Term-Asset Backed Lending Facility (TALF) which attempted to revive the derivatives market before any bank lending or domestic real investment could occur on the ground, in the hope that stirring the froth first can then let the water seep through the top soil, despite the Federal Reserve Act (FRA) permitting him to be intrusive not only in financial services – the domain of engagement of the Fed – but also in the agricultural and industrial sectors of the US economy at large even though FDR had not availed of his own amendments to the FRA.

In TALF, thus far, the Federal Reserve had done something correctly but only in half measures. Inflation is low and oil prices in a slowing global economy are fluctuating on the upside because of geopolitics in the Middle East and on the downside because of economic disruption in Europe and inflation and the attendant decline in economic growth in India.

For a technical and academic monetary economist such as Ben Bernanke sometimes a reminder of the basics can be beneficial to make sound decisions. In the world of realtime policymaking, classroom orthodoxy has no room.

These days monetary policy chiefs are flying blind beyond the M2 measure of the funds they supply and that lack of sight shows up in the GDP data. M3 to M5 are a fog and derivatives as money in flow is a question which is often avoided.

First, in Hume’s quantity theory equation MV = PY, V means real investment in the Keynesian equation Y = C+G+I+NX. Not much is being done at the moment with federal funds besides hiking financial asset prices such as J P Morgan credit derivatives in the United Kingdom leading to losses of about $6B, an unintended consequence of TALF.

Second, it does not matter what the federal funds rate is as long as inflation is in the range 1-5% and unemployment is between 4-5%. This statement implies that, at the moment, the unemployment part of the Fed mandate is a higher priority than inflation.

Third, the Fisher equation speaks volumes about the real economy – the purpose fiat money is meant to serve:

i (nominal interest rate set by the Fed) = r (real equilibrium interest rate experienced by the market participants) + pi (headine inflation, always a real phenomenon contrary to Milton Friedman’s assertions because scarcity is a real phenomenon).

Rate of technical and, hence, structural change holds the key to mitigate pi (Fed’s price stability part of the mandate) for i to be as close to r as is feasible or r = 0 when i = pi within limits.

At the moment, real equilibrium rates are negative because i = 0 and pi is > 0, in fact, close to the Fed’s implicit target of 2% in the United States.

Inflation must be greater than zero for prices not to fall drastically. At least pi = 1 is better to avert deflation and, hence, depressions as can also be seen from past Federal Open Market Committee (FOMC) transcript conversations between former Federal Reserve Chairman Alan Greenspan and former Fed economist, Governor, President of Federal Reserve Bank of San Francisco and now Vice Chair of the Fed Board in Washington Janet Yellen.

The bandaid of higher oil prices because of geopolitical anxieties and higher food prices because of a summer drought in the United States to raise inflation is not proper policy making.

US economy must be reflated back to the 2 to 5% headline range not by loosely-coupling financial assets from real assets (or more technically lowering the correlation between real economic growth rates and financial asset price growth rates) to prop up consumption by wealth effect as a substitute for higher domestic real investment and growth beyond the medium term but by forcing structural change from now into the long term through a more intrusive monetary policy in accordance with the FRA.

The Congress is not responsible nor is the US Treasury for the state of the US economy. Ben Bernanke of the Federal Reserve – whose reconfirmation vote of 70-30 in 2010 was the most contentious despite the support of the White House because of his intransigence on policy and transparency in Wall Street bailouts – is.

Ben Bernanke must resign.


About Chandrashekar (Chandra) Tamirisa
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One Response to The Case For Structural Monetary Intervention

  1. On Linkedin,

    Edward Ingram • Chandra, when you write:

    “it does not matter what the federal funds rate is as long as inflation is in the range 1-5% and unemployment is between 4-5%. This statement implies that, at the moment, the unemployment part of the Fed mandate is a higher priority than inflation.”

    What do you see happening to inflation and interest rates in such an end game? How will such interest rates be managed by lenders and what will be the effect on property markets?

    Chandrashekar Tamirisa • Interest rate is the opportunity cost of money: alternative utilizations of a lender’s funds or allocation among investment choices available to a lender.

    From a central banker’s monopoly (note seriously the word “monopoly” – not the game) money issuance perspective, the macroeconomic rate of change of the aggregate price level a.k.a inflation and unemployment rate are the yard sticks.

    Lenders must keep in mind their lending portfolios. Interest rates will be higher to borrowers for activities which do not keep prices stable or raise unemployment and lower, vice versa.

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