The Fed’s Real Challenge Is Its Loss of Credibility, Not How It Handles the Next Downturn
By Daily Bell Staff - July 06, 2016

Where the Fed Will Be When the Next Downturn Comes … The easy-money policy may bump inflation over 3% in the next few years, setting up interest-rate increases. -WSJ

This article in the Journal provides us with a scenario regarding another slump and how the Fed will react.

It is written by Martin Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan and a member of the Journal’s Board of Contributors.

The notable point of the article is that despite conversations about tightening, easing is going to be the Fed’s continued stance.

Beyond this, Feldstein’s perspectives are not remarkable. However, notably, the article’s feedbacks are more broad-based and skeptical than Feldstein’s perceptions.

They show us how the public’s insights are quickly outstripping monetary information in even the largest mainstream publications. First, Feldstein.

Feldstein certainly doesn’t make radical points regarding how the Fed might operate over the next few years.

He begins by reminding us that Janet Yellen’s June 21st testimony before the Senate stated the chances of a U.S. recession this year were “quite low.”

The key question, he points out, is what to do when the next downturn does come.

When the U.S. economy headed into recession at the end of 2007, the Fed cut the short-term federal-funds rate by three percentage points within 12 months. But it can’t do that anytime soon with short rates at less than 1%.

And raising the federal-funds rate now to 3% or more would push the economy into recession.

He follows this with the observation that “Fed policy is headed down a path that could eventually solve this problem.”

The logic here is that the Fed plans to continue an easy monetary policy over the “next few years.”

Given Ms. Yellen’s fairly frequent references to rate hikes, this is a surprising statement. But Feldstein seems confident.

He predicts that such a policy will drive price inflation to around 3%.

Once inflation is at 3%, the federal-funds rate could be upped as well, “reaching at least a 3% nominal rate, while still keeping a low or negative real fed-funds rate.”

What would be the upshot? If the Fed can raise the rate of inflation along with the fed-funds rate without recessionary effects, the problem of not having a high enough rate will be removed.

The downside according to the article is that an easy monetary policy going forward will make markets nervous. However, the Fed could argue that moving the inflation rate toward 3% is necessary because higher rates are dependent on it.

Feldstein also points out that when “the U.S. economy does experience the next economic downturn, economic recovery need not depend on monetary policy alone.”

He calls for a short-term fiscal stimulus plus spending reductions. And he hopes that once the election is finished that attention will be paid to designing such a policy in advance of the actual event occurring.

The problem with all of the above, of course, is that it rehearses monetary policy that has brought us to a particularly awful point in time: The current economic climate is miserable, far worse than Feldstein acknowledges.

He talks of rates and inflation but the real problem in the US and the world is a quasi-depression that has not departed since 2008.

No monetary policy has surmounted that. And Feldstein’s idea that carefully crafted monetary policy can make a difference at this point seems at least questionable.

As noted, feedbacks seem to outstrip Feldstein’s insights. Here’s an example:

One long op-ed describing the inner works of the Fed’s Keynesian buttons and “control knobs” that are pushed and turned as a purported means to control the economy through the supply of money and credit.

Or as the Austrians would say, a nice description of how the Fed will usher in the next bust-boom (aka business) cycle …

Ten years ago, or even five, a mention of Austrian economics in the feedback section of a major daily publication would have been most surprising.

But one reason that central banking has come under fire in the ‘teen 2000s is because more people are aware of how central banking works and the Austrian arguments against it.

Additionally, people are very skeptical of government numbers these days. The feedbacks mention that inflation is a good deal higher “in the real world” than the 2% Feldstein presents.

Conclusion: Feldstein may provide us with a logical scenario for anticipating the next decline. But a larger issue continues to be whether central banking in general and the Fed in particular have lost a critical amount of credibility. If so, then challenges to the Fed may primarily involve its survival as currently constituted rather than how it faces the next downturn.


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  • Praetor

    Another slump, another BUST, with a KABOOM!

    Faith, is what is being lost. Faith in a piece of paper will make you’re life better is ‘loosing’.

    The world is really not about money and economics. Its about life, and its abundance. Debt, limited recourses economy will always be a bust, because it has limits!!!

  • Sven

    3% inflation in the next few years? How about now?

  • r2bzjudge

    “Where the Fed Will Be When the Next Downturn Comes … The easy-money
    policy may bump inflation over 3% in the next few years, setting up
    interest-rate increases. -WSJ”

    Inflation is over 3%. People are having difficulty paying for rent and medical coverage, let alone everything else.

  • chrisyew

    The reason why Fed cannot save the economy at the next recession is that Fed is already in the market. Pumping the market with liquidity only increase the magnitude of the next crash. The debt financial monster need new cash to keep it going and it will keep sucking good money plus Fed’s cash into it to increase exponentially. The real economy will continue to decline and this is the fundamentals that support the financial instruments, call them whatever they are like stocks, bonds, derivatives, repo, etc. The real support is not supported by the liquidity which goes straight into riskless financial products. Positive interest rate on money creates the risk to reign in excesses in financial sector and these mad people want or had made it negative. The economy will grow only on an exponentially growing debt and we are at the point of sudden collapse which Fed or any central banks in the world cannot save. The system will fail and an alternative on hot standby must be ready for money to move to or the trading system will fail at the same time.

  • Bruce C.

    I say let dopes like Feldstein keep talking. Publicize their commentary as much as possible. Make them hang themselves. Accompany every “monetarist” commentary with common sense and a warning that WHEN the next financial crisis occurs it will be BECAUSE of their policies.

    But that’s not proof that their policies are wrong, you say? No, it’s proof that their policies aren’t right, and that their failures are predictable.

  • EDD

    DB: “The problem with all of the above, of course, is that it rehearses
    monetary policy that has brought us to a particularly awful point in
    time: The current economic climate is miserable, far worse than
    Feldstein acknowledges.” Also: “But one reason that central banking has come under fire in the ‘teen
    2000s is because more people are aware of how central banking works and
    the Austrian arguments against it.”

    I get emails from different ‘experts’ daily. What to buy and what to avoid. This one recommends gold; another advocates holding off. Anyone with a fundamental grasp of economics knows that when stock values are light years above earnings, failure is around the corner. Many believe Keynesian economics can supply the solution because they have been brainwashed with indoctrination. Because Keynesian economics have been the backbone of our system so long, those believers in this system cannot fathom market forces when those forces are free to adapt.

    So, yes, monetary policy has brought us to this point. And those who are become aware of how central banking works are growing exponentially. Much like a bomb, some component has to reach ‘critical mass’. What is the component of critical mass in the public before it reaches an explosion of information that cannot be denied?

    It has similarities to the Tower of Babel; and in this modern day equivalent, it is a tower of babel. Just as that tower came to it’s demise, this modern day equivalent has reached it’s highest point. The base is quivering and TPTB know this. The cancer of this system is so deeply rooted, (and indeed had it’s origin in it’s very design), that no matter how many band-aids is put upon it or how many minor surgeries are performed, the end point has been reached.

    A system that prints ‘money’ and puts it into circulation without precious metals backing it cannot continue. Especially since that money is now taxed many different ways and, mysteriously, no money was printed to pay back these taxes. Talk about a black hole; but in this case, the black hole is causing the misery of untold millions as it sucks the life blood out of those slaves who must use the ‘system’. How long before the tower falls completely? Much sooner than many realize. We are at a point of no return and one of transition. We are watching the transition as it develops.

  • chrisyew

    There is a lesson to be learned from this Greenspan monetary system. Store of value cannot be based on fiat money that can be created out of thin air. It must be based on something real like precious metal and the value will reflect the real increase in the real economy. As the price increase, so will the wealth increase. Presently, Greenspan thought he could stop the stop the recession by just pumping money. The problem is that the unpaid/unpayable debts get rolled over with more debt added to the economy as the economy grew. Excess money simply pumped up asset prices as most did not go to the man on the street. They have to create new financial assets to soak up the liquidity which created another crash point. Examples are the CDOs, CDO squared and CDSs of the mortgage category. It is not too complex to understand them. The Wall geniuses did not want the public to know too much to question them. The same can be said for the repo and reverse repo. With a strong media, financial experts should be writing tons to educate the public on how these works and how dangerous they are to be so opaque. Greenspan monetary system is simply ‘pump up the assets and the money will flow into the economy’. To prevent any leakage, money cannot be allowed to flow into precious metals. We have come to a point where the financial sector cannot have enough of the liquidity. Fed can keep providing liquidity but people have to keep accepting the money. At what point will they stop playing like kids stop collecting trading cards. What are the trading cards worth at that point. At the moment the ponzi keeps growing exponentially. Since 2008, it had consumed $25 trillion from Fed plus all the QEs, $25 trillion from China’s new debt, Mario’s ‘whatever it takes’ QE of similar trillions, QE from Japan and surely money printing from other smaller countries too. Can the world QE to prosperity or the other way. This is the Greenspan ponzi that was sold to the world. Next time it will be called greenspan rather than ponzi.

  • Toufic Abu Alwan

    Dicussion is relative as monetary policy is going ashtray due to financial manipulation although that some people beleive that austrian economy can help to clear the mess but in my opinion the main change should WORLD FINANCIAL SYSTEM in which no one can play with the world economy for his own advantage