Harsh critics of the Federal Reserve come to their views
from different perspectives. There are the libertarians, such as Ron Paul who
wrote the 2009 book, End the Fed;
there are the hard money types who are critical of fiat money; and there are
those on the left who view the Fed as part of a capitalist conspiracy to enrich
the financiers and impoverish the working class. Most of the people espousing
such views seem to have a rather fragile grasp of how a modern economy and its
banking system work. At times, even some prominent economists seem confused
about the mechanics of the monetary and banking system, as I discovered early
in my career while studying Eurodollars.
Most people only have a dim understanding, if that, about the
nuts and bolts of monetary policy. Moreover, it is a subject of vehement debate
among economists and policymakers on how to formulate the correct monetary
policy in the face of different economic conditions. If you ask Paul Krugman
what the Fed should do, you’ll get one answer; if you ask John Taylor or Martin
Feldstein, most of the time, you’ll get a different answer.
There
is no reason to believe that Danielle DiMartino Booth, a former Federal Reserve
Bank of Dallas employee, does not understand the mechanical aspects of monetary
policy, but her ability to make a cogent monetary policy argument is lacking
based on the evidence in her book, Fed
Up: An Insider’s Take on Why the Federal Reserve is Bad for America. The
book’s title is perhaps hyperbolic; she is not advocating to end the Fed but to
reform it. Among her suggestions: redraw the Federal Reserve Bank District lines so
that they “better reflect America’s economic powerhouses,” such as California;
reduce the terms of Federal Reserve governors to five years; give all Federal
Reserve Bank presidents a permanent vote on the Federal Open Market Committee
(“FOMC”); and “slash the Fed’s bloated Research Department.” Of course, none of
this is likely to happen, and the idea of the Federal Reserve Bank presidents
able to outvote the governors (there are seven governors when the Board is at
full strength and twelve presidents, of which five have a vote at any one time
on the FOMC) is particularly problematic. The Federal Reserve Bank presidents
are not federal government employees, nor are they appointed by the U.S. President.
(They are though approved by the Federal Reserve Board.) Having representatives
of the private sector directly involved in deciding on government policy with
respect to interest rates and the money supply raises, it has been noticed, Constitutional
questions which so far have been ignored or dismissed by courts for lack of
standing of potential litigants. But the issue would be more vigorously debated
if the FOMC were to outvote the governors, especially if that happened often.
But Booth’s proposal is not going anywhere, and the FOMC will likely continue
to operate as it has without significant challenge.
Booth believes that the Fed under Greenspan, Bernanke, and
Yellen has been too loose, and she is particularly critical of the quantitative
easing programs. While she argues that this has had terrible effects, she is not
clear what these effects are or why she thinks this. A perusal of FOMC
transcripts shows that a man she clearly admires and for whom she worked,
Federal Reserve Bank of Dallas President Richard Fisher, was continually
worried about QE causing inflation. He has been wrong, a fact that Booth does
not discuss. One can argue that QE has not been that effective, since large
increases in the Federal Reserve’s balance sheet did not lead to large
increases in the money supply (M2), but given the aversion of Congress to do
more than it did in providing fiscal stimulus, what choice did the Fed have but
to do what it could? One senses that Booth is not in favor of fiscal stimulus
because of fear of federal deficits. A tighter monetary policy and less federal
spending would have been a disastrous combination of policies to counter the
Great Recession.
At one point, Booth blames Fed policy for income inequality.
She does not explain how she thinks monetary policy plays a role in that. Part
of the problem is that she seems to think monetary policy is all that matters
when it comes to economic policy. Tax policy, regulation, fiscal policy,
international trade agreements, and various government programs all have their
role, which she generally ignores. As for growing income inequality, there is
no consensus among economists why this is occurring. For example, there was a
focus on this issue at the IMF-sponsored seminars at its recent annual meeting.
It was clear from those seminars that there is confusion among economists as to
the causes of growing income inequality, which is not just a U.S. issue.
Booth is on firmer ground when she criticizes Federal
Reserve supervision of financial institutions. It has at times not been as
rigorous as it should be, and the Fed missed and did not address the
increasingly risky behavior taking place in the buildup to the financial
crisis. Other regulators, such as the Office of the Comptroller of the Currency
and the SEC, also did not use their authority to address the increasing risks.
With respect to regulation, Booth makes a major factual
error early in the book when she states that collateralized debt obligations
(“CDOs”) were not regulated because they were derivatives. In fact, CDOs are
securities over which the SEC has jurisdiction. It is true that derivatives,
such as credit default swaps, are not securities and these instruments prior to
the enactment of the Dodd-Frank legislation, were not directly regulated;
however, many of the financial institutions making markets in or using these
derivatives were regulated. The SEC should have used its regulatory authority
to address the inflated credit ratings of some of the tranches of CDOs, and the
bank regulators should have used their regulatory authority to rein in the
banks. Also, the Fed should have used its authority on mortgage lending to
address the abuses that were occurring, but Greenspan famously rejected doing
so.
While I am highly critical of this book, it is fun to read.
The author writes well, and her criticism of Fed culture which tends to
suppress ideas that do not coincide with the internal consensus likely has some
merit. Her recounting of her experience working at the Dallas Fed are interesting,
though she does go overboard in her criticism of economists who have Ph.Ds. I
think she does have a point about the consensus culture of the Fed (though it
may be exaggerated for effect) based on my years of working at the U.S.
Treasury, which included working with Fed staff, but I also think Fed
economists were right in rejecting her ideas as well as those of Richard
Fisher.
Finally, there is a useful debate about whether and how the
Fed should react to asset bubbles. A particularly egregious failure of the Fed
was not to recognize that a housing bubble, partly fueled by reckless mortgage
lending, was occurring before the financial crisis. It was obvious, if the
severe fallout that would occur when the bubble burst was not. At the time, Fed
economists minimized what was happening and argued that any local, frothy
housing markets did not pose severe risks to the U.S. economy. Examining this
failure as well as considering the Fed’s responsibilities concerning asset
bubbles when inflation is contained is worthwhile. Unfortunately, this book
does not do that. Though the Fed did some things that I would criticize to pull
the country out of the Great Recession, overall, I would give the Fed high
marks. Booth would not. The main problem with Fed policy was prior to the
financial crisis, and the groupthink that Booth criticizes contributed to that.
