On Saturday the New York Times had a very interesting write-up (buried on page B6) of Harvard University professor Larry Summers’ Friday panel discussion with Ben Bernanke at a Washington International Monetary Fund conference. The article, “Candid Criticism of the Fed,” quotes Summers as saying, “There’s no evidence of growth that is restoring equilibrium.”
Summers raises the possibility of a time when “the zero nominal interest rate is a chronic and systemic inhibitor of economic activity.” Professors Ron McKinnon, Gary Becker, Allan Meltzer, and John Taylor have made the case in the Wall Street Journal and elsewhere that Fed policy is already inhibiting growth, capital allocation, and market-based pricing.
Recent news reports have focused on the positive aspects of recent data (204,000 job gains in the establishment survey, 2.8 percent third quarter GDP growth.) The establishment survey treated furloughed employees as still-employed during October, so there was not much effect from the shutdown in that survey. The household survey, which includes jobs at smaller businesses and a portion of the informal economy, has been giving a much weaker picture of employment, less than 50,000 job gains per month on average over the last year. The strength in the third-quarter GDP data was mostly due to an inventory buildup. There was marked weakness in business investment and consumption.
Many of the surveys (establishment survey, ISM, non-manufacturing ISM, components of the GDP report) give heavy weight to big companies. They are beneficiaries of Fed policies and are still reporting positive growth. The problem, as Dr. Summers is pointing out, is that growth in the broader economy is very weak, giving little evidence that monetary policy is working.
The newly-released Fall 2013 Cato Journal includes a number of papers questioning the Fed’s monetary policies, including papers by John Taylor, Allan Meltzer, Charles Plosser and Kevin Warsh. There is an important paper by Tom Hoenig, vice-chair of the Federal Deposit Insurance Corporation on the need for simpler regulatory rules such as leverage ratios to protect depositors. The Cato publication also includes my paper, “The Fed Needs to Change Course”, discussing the contractionary effect of the Fed’s policy.
I do not think outside questioning can force the Fed to alter course, but it is possible that the Fed’s internal discussions will gradually incorporate questions such as those of Professor Summers. If it wants to change, the Fed has wiggle room with the phrase “data dependent.” Chairman Ben Bernanke and Vice-Chairman Janet Yellen might begin to de-emphasize the importance of bond buying and put more emphasis on forward guidance. I do not think forward guidance works, but it might be a useful diversion to get the Fed away from its $85 billion per month quota. Because the Fed’s asset holdings are plain vanilla and private sector credit has not grown much (the Fed has not printed money and is rechanneling credit rather than creating new credit), I do not think it will be that difficult for the Fed to inch toward an exit once it starts. The bigger problem is that growth is already very slow, so the Fed will need to make clear that tapering will help the economy as a whole even though it may initially hurt those being subsidized by Fed policies. Summers’ comments yesterday offer a starting point for an evolution in the Fed's rhetoric to more open-mindedness on whether current policies are working and whether changes might be helpful.
David Malpass is the President of Encima Global
