September 08, 2010
Dean Baker
The Guardian Unlimited, September 8, 2010
See article on original website
Many have noted the resemblance between the Federal Reserve Board and the Catholic Church. Both have long traditions of secret convocations: meetings of the Open Market Committee and the College of Cardinals. Both have a revered leader: the Chair of the Board of Governors and the Pope. And both have claims to infallibility.
OK, it is only the Pope who can explicitly claim infallibility. In the case of the Fed Chair, infallibility is bestowed by the business reporters and politicians who treat every word from the reigning Fed chair as a priceless pearl of wisdom.
This aura of infallibility is especially painful in the current economic situation when error seems to be the new religion of the Fed. Just to remind everyone – since so much denial has dominated the debate – the only reason that we are facing near double-digit unemployment and the worst economic calamity in 70 years is that the Fed was out to lunch in combating the housing bubble.
The Fed was apparently unable to recognize a massive and unexplained departure from a 100-year-long trend in the largest market in the world as a bubble. Even after they had just seen the stock bubble grow and implode they still could not conceive of a bubble in the housing market. Bernanke and other spokespeople for the Fed have also claimed that there was nothing that they could have done even if they did recognize the bubble.
Call this colossal error number one. This is drunkenly driving the school bus into the lane of oncoming traffic killing all aboard. In most lines of work, you would be fired immediately and barred from ever working again. For the Fed chairman this is just a bad break.
Having missed the largest financial bubble in the history of the world, Bernanke quickly moved to colossal error number two, failing to take adequate steps to counteract the downturn. While Bernanke deserves credit for being more aggressive than some of the quacks who would have just let the financial system melt down completely, his response to mass unemployment has been woefully inadequate.
The Fed should be targeting a higher rate of inflation in the 3-4 percent range. This would reduce real interest rates and debt burdens. What is the downside in this picture; inflation accelerates too much and hits 5-6 percent? How does that compare to years of excessive unemployment with millions of people unemployed or underemployed needlessly? No reasonable calculation of costs and risks would justify Bernanke’s timidity in the current circumstances.
Bernanke’s third colossal error is playing along with the deficit fervor being promoted by those seeking to gut Social Security, Medicare and other areas of social spending. The downturn has predictably led to an explosion of the deficit, as public spending had to fill the gap created by the collapse of private spending.
However there is no reason whatsoever why this deficit should place any burden on the long-term federal budget. A responsible Fed chairman would announce his intention to simply buy and hold the government debt used to finance the deficit. This would prevent the debt from placing any future burden on the public budget since the interest payments on the debt would go to the Fed. The Fed would in turn refund the interest to the Treasury each year, leaving no net interest burden on the government.
Japan’s central bank currently holds an amount of public debt that is almost equal to its GDP ($14.5 trillion in the case of the United States). As a result, Japan’s interest burden is less than that of the United States even though its ratio of debt to GDP is 220 percent, almost four times the ratio in the United States.
If Bernanke were honestly doing his job he would be educating the public about why debt run up to counteract a downturn need not impose a burden on the budget. Instead, he is running around telling Congress to cut Social Security because “that’s where the money is.”
The country is paying an enormous cost for Bernanke’s trifecta of errors. In any other line of work any one of these errors would be huge enough to have someone drummed out of the profession. But the Fed has more in common with the Catholic Church than it does with normal institutions. As a result, Pope Bernanke is really messing up big time, yet he is still being allowed to wear the mantle of infallibility and the rest of us are being forced to suffer the consequences.
