Kevin Warsh, a former Federal Reserve Board governor, recently wrote an op-ed for The Wall Street Journal, “The Federal Reserve Needs New Thinking.” The article could have benefitted from an editor making helpful suggestions, because, as it reads, it expresses more the author’s anger at the Fed and what he views as academic economic thinking than a coherent argument. This is not the way to write a persuasive essay.
This is not to say that Mr. Warsh does not make some valid points. For example, it is true that the Fed and other major central banks have not been able to push inflation up to their target rate of 2 percent. That does not mean it is “puzzling” why some economists want a higher target inflation rate. You do not have to agree with the argument that, in a period of “secular stagnation,” higher inflation rates are necessary so that central banks have more latitude to push real interest rates lower into negative territory to be puzzled by the reasoning. In fact, I am suspicious of the merits of a 4 percent inflation target, not because of any serious empirical study, but because I fear, given the experience of inflation during the 1970s, once inflation gets that high, the risks are that it will go higher and bringing it down will be painful. The arguments of the proponents, though, are not puzzling.
What Warsh does not quite say is that the inability of achieving inflation of 2% demonstrates the limits of monetary policy in the current economic conjuncture. The argument that the Fed has been too aggressive in monetary policy seems to be based on disquiet at the growth of its balance sheet, rather than the effect the expansion of the monetary base has had. In this connection, it is instructive to look at the collapse of M2 velocity (nominal GDP divided by a measure of the money supply, M2).
The Fed has been aggressive in expanding its balance sheet because the economy is not getting much of a boost from fiscal policy. While the graph indicates that there are limits to what the Fed can achieve, the Federal Open Market Committee decided that doing something during a time when Congress was unwilling to increase spending was prudent. It is hard to argue with that, but Warsh seems to.
Warsh also speaks of “monetary, regulatory and fiscal errors” without specifying what these errors are. I suspect that Warsh does not mean that fiscal policy should be more expansionary in terms of increased spending, though, of course, he might be in favor of tax cuts. He also might mean that the budget deficit should be brought down faster; there is no way to tell from his article. Also, the limits to the efficacy of monetary policy does not help Warsh’s argument that the Fed is too powerful, though one can make a different argument than Warsh does that this is the case.
Warsh’s attack on an “economic guild” and groupthink is also muddled. One only has to read articles by various economists to know that there is little consensus, academic or otherwise, about macroeconomic policy. Given that Warsh is currently at the Hoover Institution, he must be familiar with John Taylor, who rarely agrees with Paul Krugman. What I suspect Warsh is incensed about are the views of the powerful Federal Reserve Board staff. From what I have observed when I worked at Treasury, I suspect that the Board staff can make life less than pleasant for a governor who habitually disagrees with them. I do not know whether that was the case when Warsh was at the Fed, but, if it was, that could explain Warsh’s anger at groupthink. There may be some groupthink at the Board, but there is little evidence of groupthink among economists generally. In fact, there is robust argument.
Warsh contends that “citizens are rightly concerned about the concentration of economic power at the central bank.” That may be true of the people whom Warsh knows and talks to, but I doubt that is generally true. Most people only have a vague idea about what the Federal Reserve does or what its powers are. Attacking the Fed, as Ron Paul has often done from a libertarian perspective, only works marginally as a political argument. Leftists who argue that the Fed is dominated by bankers do not do any better.
The implication of Warsh’s argument that the Fed should do less is one with which I doubt he agrees. In a time of low nominal interest rates, it would make sense to help the economy for the government to spend more to put idle resources to work. A good place to start is infrastructure spending. Infrastructure improvement is needed in this country and there should be increased spending to make sure our bridges, highways, airports, public transportation systems, rail lines, water and sewer lines, natural gas mains, etc. will serve us well going forward. In some instances – the DC Metro comes to mind – they are currently failing. What better time to do this than when the economy is sluggish and it costs next to nothing for the Federal government to borrow. But, of course, the deficit hawks will squawk at this and insist on spending reductions elsewhere in the budget. The case remains, though, that fiscal policy could relieve pressure on the Fed to continue an aggressive monetary policy, but I doubt Warsh would agree with this.
Warsh’s article is a muddle. During the George W. Bush Administration, I met him when I was working at Treasury and he was at the White House at a meeting on a regulatory issue, though I would be surprised if he remembered me. He seemed quite smart, though perhaps a bit ideological for my taste. My impression is that he could write a much better article.