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.
