Out of Control Policy Blog

Bernanke's Experiment: Monetary Curiosities and Actualities

Last week, the Fed announced a second round of "quantitative easing" to inject money into the economy via purchases of government debt through primary broker dealers. Basically, the Fed is firing up the digital printing presses to stimulate the economy by making it cheaper to borrow money. There has been a lot of debate over whether this will work (see my post from last Friday). But perhaps a deep question is whether this is an appropriate role for monetary policy.

In a paper published this week, my co-author and I argue that the Fed's traditional dual mandate—to maintain price stability and full employment—is problematic and should be changed. But even if we were to assume this was the appropriate goal of monetary policy, the Fed's actions are still very non-traditional and unconventional. The Fed's balance sheet will have more than tripled once the new debt purchases are made, and all to circumvent the spending authority of Congress, which Chairman Bernanke doesn't see moving the way he would like.

Taking up this point, John Hussman wrote on Monday: "Given that fiscal authority is enumerated by the Constitution as the sole right of Congress, and spending is prohibited by the Constitution without explicit appropriation, it seems clear - regardless of how the Federal Reserve Act is written - that monetary operations involving anything but Treasury securities contain unconstitutional “fiscal component,” unless they involve repurchase agreements that would make the Fed whole even if the underlying securities were to fail. It is doubtful that when Congress drafted the Federal Reserve Act to allow the use of mortgage-backed securities, it ever dreamed that the Fed would purchase these securities outright when the issuer was insolvent."

Chairman Bernanke has essentially taken the economy into his own hands, despite the voter backlash against the Washington culture of adding debt to solve the debt problem. Ironically, Professor Bernanke from 11 years ago believed exactly the opposite of the FOMC's current action. Here is a piece of his argument in a paper about Japan:

In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, which would arise, for example, if the BOJ purchased nonperforming bank loans at face value (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any  money-financed transfer does. Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan, if only because it is more straightforward for the Diet to vote subsidies or tax cuts directly. Nonstandard open-market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.

The emphasis added is mine, and to point out that Chairman Bernanke has directly violated this principle. What should have been a "theoretical curiosity" has become a monetary actuality. At what cost remains to be seen for this experiment.

Anthony Randazzo is Director of Economic Research


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