The American Enterprise Institute (AEI) hosted a panel titled "Leadership Challenges Facing the Next Fed Chair" on Sept. 19 to discuss issues that will face the next chairman of the Federal Reserve.
The audience was invited to imagine that they were going to be the next chairman and receiving advice from these experts: Peter Fisher, senior director at the BlackRock Investment Institute, senior fellow at the Center on Global Business and Government at the Tuck School of Business at Dartmouth College, former Under Secretary of the Treasury for Domestic Finance and former manager of the Open Market Account at the Federal Reserve Bank of New York; John Makin, former consultant to the International Monetary Fund, the Treasury and the Fed, now at AEI; and Stephen Oliner, an economist at AEI and senior fellow at the University of California, Los Angeles' Ziman Center for Real Estate.
AEI's Alfred Pollock began the conference by quoting a Wall Street Journal headline: "Fed Stays the Course on Easy Money" and suggesting it should read: "Fed Continues to Massive Bond Market Manipulation." He posted a chart showing that the long-term rate of increase in household wealth has been 3 percent, with a couple of pronounced bubbles in recent years. Therefore, to say that billions of dollars of household wealth has been destroyed is wrong, because, duh!, they were bubbles.
Another chart showed that the Fed's balance sheet is over $3.5 trillion. Taking into account equity of $55 billion, the Fed is leveraged 67:1, and its capital ratio is a trivial 1.5 percent. Pollock might have added that these figures place the Fed in the category of "too big to fail" and would call for it to be put through a process of resolution.
Fisher listed three primary challenges facing a new Chairman — finding the right policy, achieving consensus on the Federal Open Market Committee (FOMC) and communicating and implementing the policy through the financial markets.
These challenges, in turn, present five problems: 1) Get out of the business of immunizing the economy against fiscal policy dysfunction in the areas of taxing, spending and borrowing; 2) the FOMC has been having catfights about an issue called the "labor participation rate," whether the observed decline is cyclical or structural, and the Committee should consider a paper by five Fed economists in 2006 that exactly predicted what would happen; 3) consider the limits of monetary policy and whether there is a limit to the ability to influence the course of economic indicators by buying bonds (I suspect that the Fed will respond to this concern not by cutting back the purchase of bonds but by expanding into buying stocks); 4) individual FOMC members indirectly express dissent by the anonymous placement of dots on a chart indicating rather diverse forecasts of the federal funds rate over the next few years; and 5) clarifying the role of expectations that the FOMC has found difficult to manage, despite the fact that Chairman Ben Bernanke has said not to worry.
Makin followed with a similar theme, stressing the broad challenge of weaning markets and politicians from the idea that the Fed can fix everything. He lamented that the crisis caught policymakers by surprise. (One wonders how this can be the case, given that it has been going on for at least four decades.)
He mused further that the markets and politicians have looked to the Fed to do too much. I would observe that when Bernanke warns that there are limits to what monetary policy can achieve, markets and politicians find his words hollow, because he has already gone beyond traditional limits to a heroic extent and has firmly taken ownership of what used to be the "Greenspan put," and may soon be known as the "Yellen put" or the "Ferguson put," the assumption that the Fed will bail out any illiquid asset, provided that it represents a large enough interest to threaten the stability of the financial system.
Further, Makin challenged the notion that the Fed has a room full of levers and valves it can adjust to achieve desired results for the economy. He argued that it is not clear the Fed can produce sustained results in employment, for example, as assumed by adherents of the "Phillips curve," which postulates a relationship between inflation and unemployment.
He suggested that the Fed should adopt an inflation target, which would call for inflation not to rise above 2 percent or get too close to zero on the downside. Makin quipped that the Fed put its manifest in the pattern the stock market has established of going up on bad news, because it means that quantitative easing (QE) will remain in effect, and it goes up on good news, because it's good news. He asserted that the Fed cannot support rising stock prices forever, and he warned that, given the 2008 experience, the Fed should stop thinking and saying that it can't act to prick financial bubbles.
Finally, Makin implored the Fed to "do something" about the poor performance of its forecasting. (I would suggest firing the Fed's forecasters and replacing them with subscriptions to the private services that do better.) He stated flatly that Fed forecasts are consistently too optimistic, and he wondered how long the Fed could maintain this posture as the economy continues to languish. Later, Makin vainly admonished the Fed to preserve a dose of humility.
Oliner, making the last presentation, listed four challenges for the next Fed chairman: 1) how to normalize policy; 2) how to improve communication; 3) the need to think hard about how add financial stability to its mandate; and 4) while he does not perceive this as an immediate issue, take care to preserve its independence.
As a cynic, I would respond: 1) the current policy of out of control expansion of the balance sheet under QE is "the new normal"; 2) the markets have figured this out, regardless of what the Fed says, and only one FOMC member dares to dissent against a more or less permanent majority that supports aggressive intervention in the economy; 3) the Fed has established itself, along with the Treasury, as the principal sources of instability in the economy, and 4) the Fed has long since given up its independence, as Bernanke demonstrated his willingness, even eagerness, to walk two steps behind Treasury Secretary Tim Geithner.
More specifically, Oliner stated the Fed needs to decide how it will exercise its power to augment capital requirements for the largest banks. (I predict that all of the so-called regulators will continue to enable the banking industry to operate with high leverage as the Fed itself pursues the same strategy.)
For Oliner, it would be prudent for the Fed to look after its independence now, rather than neglect this concern until a Republican might be elected who would seek to "clip the Fed's wings." (I would predict that the Fed will implicitly assume that the possibility that an anti-Fed Republican would be elected is remote and that the best policy is to continue to expand its policy reach in order to preempt any action to rein in the power and influence of the Fed and its client too big to fail banks.)
Even more remarkably, Oliner called for the Fed to adopt a clear policy that QE will only be used in "extraordinary circumstances."
He must be joking. The United States has been in extraordinary circumstances for the last 40 years, during which the Fed and the cartel of zombie banks taken the doctrine of too big to fail "where no man has ever gone before."
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