Tuesday, November 9, 2010

The backlash against the Fed

The “institutional credibility” of the Fed is being tested by the global outcry over QE2. This is very bad news for four reasons: (1) it is making the Fed a political football in Congress; and (2) it provides ammunition to the hawks who place “credibility” over the dual mandate (i.e., emphasizing inputs over outcomes); (3) it weakens Chairman Bernanke’s power within the FOMC; and most importantly, (4) it will limit the ability of the FOMC to take further actions to spur nominal growth.

I had somehow assumed that the Fed could adopt QE (or even better, outcomes targetting) with little controversy. That has proven to be an incorrect assumption.

There is now a barrage of criticism of QE2  by finance ministers in Europe, Asia and Latin America. I should add that this criticism is of the Obama administration’s  alleged decision to pursue a “weak dollar” policy, which is false and which ignores the Fed’s independence. QE2 was neither an Obama nor a Geithner decision. But it is to the president’s credit that the defended the policy yesterday.

Domestically, the Fed is under attack by hard-money economists, conservative media (esp. the Wall Street Journal) and by Tea Party republicans, including now Sarah Palin of all people.  While it is too soon to know to what extent the House republican leadership understands and respects the Fed’s independence, there will certainly be pressure for hearings about the Fed’s “inflationary” and "weak dollar" policies.

This state of affairs is very disappointing. It lowers my expectations about the ability of the Fed to engineer a higher level of nominal growth, which is bad for employment growth and corporate earnings.

No comments: