Ideology, The Fed, and The Blame Game

Here we go.

The next couple of years promise to bring us lots of fun as the newly elected Republicans bring their libertarian notions into the public gaze and out from the shadows where they have lurked hitherto. Today we got off to a good start as Ben Bernanke was quizzed in one committee, while in another we heard from a professor who call Abe Lincoln a tyrant. According to him secession is the only way to bring back the liberties stolen from us by the big bank, counterfeit money socialists who now infest Washington DC.

Fun times indeed.

This is not a time to be Chairman of the Fed. The Republicans have long had a visceral dislike for anything that smacks of a central bank intent on using monetary policy to solve our unemployment problem. There are rumblings that we will see an initiative to strip the Fed of its dual mandate – on both inflation and employment – and instead restrict it to just inflation. This is in reaction to all the unconventional efforts the Fed has made to help lift the economy over the last two years. In particular opposition to QE2 has crystallized around the dual drum beats of inflation fears and Fed over reach.

So in his appearance before a Congressional committee today poor old Bernanke was grilled relentlessly about the way in which Fed policy was threatening to undermine the economy by stoking uncontrollable inflation.

‰ÛÏMy concern is that the costs of the Fed‰Ûªs current monetary policy ‰ÛÓ the money creation and massive balance sheet expansion ‰ÛÓ will come to outweigh the perceived short-term benefits,‰Û?

This was how Representative Paul Ryan, the lead GOP spokesman, put it. Those costs being a burst of inflation. Not that Ryan backed up his argument with much data about that burst. He simply pointed to rising commodity and raw material prices, and higher bond yields. Since there isn’t any sign of a surge in inflation just yet, he had to limit himself to dark warnings that if, and when, such a surge crops up it would be hard to contain.

I agree. It would be hard to contain. Inflationary expectations, once baked into prices, wages, and contracts, are hard to reverse without vigorous counter measures, usually the inducement of huge slack in the economy sufficient to eliminate both pricing power and expectations simultaneously. Those of us who lived through the Volcker recession back in the early 1980’s can recall the amount of pain needed. We all want to avoid a repeat.

So, is inflation a threat? No. This is a problem for those ideologically inclined to look for it.

Prices are rising in some economies, especially in emerging nations, where demand has increased rapidly. In other places supply constraints caused by crop failures are putting pressure on food prices. These are both real issues and we need to follow them closely. But neither have anything to do with recent Fed policy. And the US economy is not showing much, if any, sign of those problems occurring here. So Ryan’s fears are entirely hypothetical at the moment. Which, unfortunately, doesn’t prevent him from encouraging the Fed to cease its support for the recovery.

We all need to take a deep breath and be sensible here. Core inflation was 0.7% in 2010, and trending down still. In the last year before the recent calamity it was 2.7%. Since 0.7% is both negligible and below the Fed’s target range, there is no current need to react by raising interest rates. At least if you are driven by data. To raise rates now would blunt and possibly reverse the recovery. We should wait a while longer, at least until unemployment has started to trend down consistently.

If you are driven by ideology the story is very different. Hence the Wall Street Journal’s almost daily headlines about inflation fears spreading [From where to where? Perhaps from the editorial page to the front page?] The point being that there is a large group of politicians and others who are motivated not by any facts they can gather, but by an opinion they hold. That opinion being the Fed has no business helping prop up the economy. We should, they say, let the market do its work. We have heard this story before. These folks overlook the inconvenient, but noticeable, fact that it was the market that sent us tumbling into the abyss. It was a private sector failure, not a government policy failure that launched us into crisis.

Or was it?

That is, of course, just my opinion. It would be nice if we could get some objective agreement about what started the crisis boiling up.

Then again, if you read the Financial Crisis Inquiry Report published last week, the ideological divide is so wide there is no agreement about the true causes of the crisis. One side – the Democrats – gave us a dull recitation of events, and ended up blaming banks, deregulation, and the rating agencies; while the other side blamed the government. Actually the Republicans were divided into two factions. One blamed the government. And the other blamed the government even more. Overall the most reasonable comment in the entire 500+ pages of the report came from a lone right wing dissenter who wondered out aloud why American banks and personalities like Greenspan could be blamed, when a real estate bubble blew up in so many other countries too.

No one, apparently, wants to admit that economic policy in the US has been off track for decades and that the entire world was awash with cash needing a home. That cash ended up fueling ridiculous home price increases wherever delinquent bankers could get their hands on it, and wherever lax oversight, a collapse of credit standards, and mass hysteria on the part of home buyers combined to destabilize things enough. Which is to say in plenty of places. Not just in the US.

Given that the FCIC was ideologically split from the beginning it was always a long shot that it would produce anything useful. Besides it published its findings long after politicians had embarked on whatever ideologically predetermined course they chose.

Personally I go a little deeper and argue that the crisis was the logical outcome of three decades of illusion during which we undertook a sustained experiment in market based solutions to problems; reduced the government’s ability to act as a bulwark; and engaged in social engineering to induce more home ownership than is either sensible or sustainable over the long haul. In the US both political parties are culpable. And along the way no one paid attention to the huge inequality in incomes that inevitably distorted both the shape and source of demand. Of course a whole lot of people did stupid things like overpay and under save with respect to real estate. We were encouraging them to. We gave them incentives to. And getting deeply into debt was the only possible way to keep the “dream” alive: wages were stagnant.

It was this rotten wage performance that drove so many people over the edge, and made them very vulnerable to the siren song sung by the banks and other mortgage lenders who were trying to find uses for the enormous flood of credit slopping about the globe. When regular people felt their living standards under pressure, and when bankers saw an opening for enormous profit, it became a perfect storm. Desperation met lack of scruples. In other words it was government – both inaction in the form of deregulation, and action in the form of housing policy -that did it. And the private sector too. There was fraud, a remarkable collapse in ethics, greed, shiftiness, and plain stupidity. The system went haywire. We collectively lost our minds and created conditions in which predators could stalk the streets uncaring and untouched.

In such circumstances, establishing blame is simply an attempt to meet the ideological need to avoid taking responsibility.

Stagnant wages; excess credit creation; and inequality. Excessive deregulation; unfettered capitalism; and lost ethics. Imbalances all.

We need policies that re-establish balance. Not ideological bun fights over Fed activity.

How the heck calling Lincoln a tyrant fits into anything remotely useful I have no idea. But these are the things we will be hearing about for a while now.

As I said: fun days indeed.