Sez longtime Fed-watcher William Greider:
The Federal Reserve Turns Left
William Greider April 11, 2012 | This article appeared in the April 30, 2012 edition of The Nation.
Washington is lost in a snarl of confusion, cowardice and wrongheaded ideological assumptions that threaten to keep the economy in a ditch for a long time. That prospect is not much discussed in the halls of Congress or the White House. It’s as though the crisis has been put on hold until after the presidential election.
As almost everyone understands, nothing substantial will be accomplished this year. President Obama is campaigning on warmed-over optimism and paper-thin policy proposals. Republicans propose to make things worse by drastically shrinking government spending, when the opposite is needed to foster a real recovery. The president, like the GOP, embraces large-scale deficit reduction. In these circumstances, it’s just as well that the two parties cannot reach agreement. After the election they may make a deal that splits the difference between bad and worse. In the worst case, they might inadvertently tip the economy back into recession.
In this sorry situation, there is really only one governing institution with the courage to dissent from the conventional wisdom—the Federal Reserve. The central bank declines to participate in the happy talk about recovery or in the righteous sermons attacking the deficit. In its muted manner, the Fed keeps explaining why the house is still on fire, why more aggressive action is needed, and is gently nudging the politicians who decide fiscal policy to step up. But its message is ignored by Congress and the president and viciously attacked by right-wing Republicans who say, Butt out.
The stakes in this elite dialogue are enormous. The outcome will be more meaningful for ordinary citizens than any other issue at play in this year’s campaign. If the Fed is right and politicians refuse to act, Americans may be condemned to a bitter slog through many years of stagnation.
Japan in the 1990s is the appropriate comparison. After its financial bubble burst, Japan saw its “lost decade” stretch into fifteen years of stunted growth. Its central bank responded hesitantly, and its monetary policy proved ineffective—rendered impotent by a “liquidity trap,” a condition identified by John Maynard Keynes. The United States experienced a similar fate in the Great Depression of the 1930s. As an economics professor, Fed chair Ben Bernanke is a scholar of that period. He is determined not to let it happen again. A decade ago, he scolded Japanese authorities for failing to be more imaginative and aggressive. They needed “the courage to abandon failed paradigms and to do what needed to be done,” Bernanke advised. His model was Franklin Roosevelt, whose “specific policy actions were, I think, less important than his willingness to be aggressive and to experiment—in short, to do whatever was necessary to get the country moving again.”
Maybe the Fed chair should give the same lecture to American politicians. But Bernanke is at risk of embarrassment himself: despite the Fed’s firepower, it has been unable to restart the economy. And monetary policy is running out of gas. Five years ago, in the heat of crisis, Bernanke’s response was awesome. The Fed created trillions of dollars and flooded the system with easy money—enough to stabilize financial markets and rescue wounded banks. It brought short-term interest rates down to near zero and long-term mortgage rates to bargain-basement levels. It provided a huge backstop for the dysfunctional housing sector, buying $1.25 trillion in mortgage-backed securities, nearly one-fourth of the market.
Flooding Wall Street with money saved the banks, but it didn’t work for the real economy, where most Americans live and toil. The housing sector kept falling. The Fed knows (even if politicians do not) the danger of sliding into a liquidity trap, which would utterly disarm its monetary tools (Charles Evans, president of the Chicago Federal Reserve Bank, thinks the trap has already closed). So the Fed wants Congress and the White House to borrow and spend more, which, when the private sector is stalled, only the government can do. To advance this cause, the central bank is promoting its recent white paper on housing, proposing, ever so gingerly, the heretical remedy of debt forgiveness for the millions of homeowners facing foreclosure.
The august central bank is engaged in a startling role reversal. It has turned left, so to speak, abandoned old positions on fundamental matters and endorsed Keynesian principles it once spurned. Bernanke would doubtless protest that this is not about left or right, that the Fed is simply doing what it’s supposed to do in a crisis—using the stimulative power of money creation to act as “lender of last resort.” Nevertheless, for nearly three decades, first under Paul Volcker and then Alan Greenspan, the Fed did pretty much the opposite. It was the conservative authority that dominated policy-making, scolding politicians for their spending excesses and threatening to punish over-exuberant growth by raising interest rates.
A tidal shift in governing influence is under way, because monetary policy is now eclipsed. As the central bank loses control, the stronger hand shifts to the fiscal side of government. That seminal insight originates with economist Paul McCulley, retired after many years as Fed watcher for PIMCO, the world’s largest bond fund. McCulley is a Keynesian who never bought into the ideological fantasy of self-correcting markets. His views won respect at the Fed because he was right. Only politicians still don’t get it. After thirty years of deferring to conservative orthodoxy, both parties are afraid to break from the past. While the Fed pushes for fiscal expansion, Congress and the president remain obsessed with deficit reduction.
“This was not supposed to happen,” McCulley observes. “The fiscal authority was always supposed to be afraid of the Fed. The Fed would say, Don’t do this, don’t do that. And the fiscal side would back off. Now you have a situation where monetary policy is effectively impotent and the Fed is openly inviting the fiscal side to do what for decades the Fed told it they couldn’t do.” The “missing partner,” McCulley says, is the fainthearted politician who clings to old dogma about fiscal rectitude, even though the crisis has made those convictions “irresponsible.”
As a longstanding critic of the Federal Reserve, I am experiencing a role reversal of my own. In the new circumstances, I find myself feeling sympathy and a measure of admiration for Bernanke’s willingness to stand up for unorthodox ideas and to switch sides on the sensitive matter of debt reduction for failing homeowners. For many years, I have assailed the institution’s unaccountable power and anti-democratic qualities, its incestuous relations with powerful banks and investment houses. Those flaws and contradictions remain unreformed, yet I now think the country needs a stronger Fed—a central bank not afraid to use its awesome powers to help the real economy more directly.
People ask, How come the Federal Reserve can dispense trillions to save Wall Street banks but won’t do the same to rescue the real economy? Good question. They deserve a better answer than the legalisms provided by the Fed. At this troubled hour, the Federal Reserve should find the nerve to abandon “failed paradigms” and to use its broad powers to serve a broader conception of the public interest.
