Madness of a Stimulating Fed
By Staff News & Analysis - May 01, 2013

Is the Federal Reserve Insane? … Americans have been whipsawed by devastating cycles of boom and bust over the past three decades. Now some at the Fed want us to go through it again. – Bloomberg

Dominant Social Theme: The Fed is not insane. It is sensible and proactive.

Free-Market Analysis: This is an unusual article to appear in Bloomberg, especially given the headline. But unfortunately, it promises more than it delivers.

It would be nice to read a real evaluation of central banking in the modern mainstream press. But perhaps this is as close as we can expect to get. The author explains that low interest rates and money manipulation have given rise to wild economic swings and questions about the current monetary easing.

In fact, he does more than question it. He actively questions the central bankers' mental health. He basically comes out and states that by keeping interest rates artificially low, Ben Bernanke, et al. are setting the world up for yet another bubble and another crash.

Here's more from the article:

The excesses of the 1980s — leveraged buyouts, the junk bond bubble and wild property speculation — led directly to the original "jobless recovery" of the early 1990s. This occurred despite a prolonged period of very low interest rates. (The 1990 tax increases and post-Cold War defense cuts were probably counterproductive.) In many ways, that episode was a dress rehearsal for the recent crisis, so it makes sense that some of the most interesting writings about the dangers of excessive private borrowing come from that earlier time.

It didn't take long for the next boom and bust cycle to hit. In the second half of the 1990s, the irrational exuberance of stock investors fueled a binge of business spending. Real nonresidential private investment increased at an annualized rate of more than 12 percent between the beginning of 1996 and the middle of 2000. That changed once firms realized that they had been wasting their money on bad investments and unneeded capacity. Capital expenditures plummeted by nearly 20 percent between the middle of 2000 and the end of 2001. Real business investment didn't return to its pre-recession level until the beginning of 2005.

The massive swing in capital spending plunged the economy into recession and held back the recovery for years. According to the Census Bureau's Current Population Survey, real median incomes (for individuals, not households) increased at an annualized rate of just 0.2 percent from 2001 through 2007. More Americans were working in the private sector in December, 2000, than in May, 2005. Since the population of prime-age workers was expanding throughout this period, the actual damage was even worse. Again, this was in spite of the fact that real interest rates were very low for a long time and in spite of the large tax cuts and spending increases of the early 2000s.

… One might think that the Fed has learned something from this experience. A recent speech from Nayarana Kocherlakota, the president of the Minneapolis Federal Reserve Bank, suggests otherwise. He said that the Fed "will only be able to achieve its congressionally mandated objectives by following policies that result in signs of financial market instability."

According to Kocherlakota, the Fed is incapable of lowering the unemployment rate without creating more bubbles. This attitude is strange; Kocherlakota implicitly denies the possibility that the economy could ever grow at a healthy pace without the stimulus provided by unsustainable asset bubbles. More precisely, he said that the Fed needed real interest rates to be "unusually low for a considerable period of time" and that this would lead to "unusual financial market outcomes" including "inflated asset prices, high asset return volatility and heightened merger activity." Surely there must be a better way.

… Kocherlakota expects real rates to be "unusually low" for "the next five to 10 years." … There is a word for people who do the same thing over and over again, expecting different results: insane. Let's hope that they don't constitute a majority of the Fed's voting members, or we will once again be doomed to another destructive and pointless cycle of boom and bust.

This last statement is where we finally admit the article does not fulfill its initial promise. The author admirably catalogues the Fed's sins throughout the modern era but stops short of the logical conclusion that Fed policies have obviously been massively destructive.

Instead, the article concludes with the observation that the Fed ought not to keep rates low for the next five to ten years because the result will be another "destructive and pointless cycle of boom and bust."

What is it that we are missing here? Of course, the Fed will set off another destructive boom and bust cycle. In fact, it's already a given.

The trouble with central banking is that it simply doesn't yield up rational conclusions. It resists analysis because anyone analyzing it can only come up with the conclusion that the Fed and central banks generally cannot logically fulfill any of their stated functions.

The logical conclusion to this article would be that the Fed in particular ought to be shut down, given the economic havoc it's already wreaked. That this option is so obviously precluded by the statist status quo provides commentators like this one with a kind of cognitive dissonance. The logic is clear but they cannot follow it.

After Thoughts

This inability to have a rational conversation about monetary policy is the biggest reason monetary disasters will no doubt continue, just as this article predicts.