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God Bless You, Richard Fisher

James Groth
September 27, 2011, 5:45pm

Vonnegut reference aside, Richard Fisher once again has proven himself as the defender of stable and responsible monetary policy. In an environment of centralized control over our sole medium of exchange where a free market alternative has not existed for almost 100 years, Fisher is a godsend.

Fisher, the president and CEO of the Federal Reserve Bank of Dallas and voting member of the Federal Open Market Committee (FOMC), gave a speech today before the Dallas Assembly that I highly recommend anyone, and especially Fed watchers, to read. You can find it here.

In it, he begins by likening current Fed policy to a passage written on a sign outside a Norwegian meteorological station situated on a desolate volcanic island deep in the heart of the Arctic Circle. From the speech:

“Theory is when you understand everything, but nothing works.”

“Practice is when everything works, but nobody understands why.”

“At this station, theory and practice are united, so nothing works and nobody understands why.”

My wry brother implied that this about summed it up for monetary policy. Drawing on theory and practice, the 17 members of the Federal Open Market Committee (FOMC) have been working in the harshest economic environment to harness monetary theory and lessons learned from practice to revive the economy and job creation without forsaking our commitment to maintaining price stability. But the committee’s policy has yet to show evidence of working and nobody seems to quite understand why.”

Further into the speech he presents his rationale behind his dissent from the most recent Fed decision to begin “Operation Twist”, as well as his previous dissents to prior monetary easing programs. Regarding QE2, Fisher states that the benefits of adding $600 billion in assets to the Fed’s already bloated balance sheet are small relative to the cost, and that it was “influenced too heavily by the financial interests that make more money from trading than from lending to job-creating businesses."[emphasis mine] I could not agree more, and I’ve been highlighting how banks have been making money off the Fed’s actions for a while now and as recently as the last FOMC decision.

Regarding his dissent at last week’s meeting, Fisher lists four main points to highlight his aversion to the recent Fed action to purchase $400 billion in longer-dated Treasuries while selling those of short maturity. He also states an essential factor leading him to vote “no”:

  1. “Embarking on an Operation Twist would provide an even greater incentive for the average citizen with savings to further hoard those savings for fear that the FOMC would be signaling the economy is in worse shape than they thought. They might view an Operation Twist as setting the stage for a new round of monetary accommodation―a QE3, if you will. Such a program was considered redundant by business operators given their surplus of undeployed cash holdings and bankers’ already plentiful excess reserves. In addition, such a program might frighten consumers by further driving down the yields they earn on their savings and/or lead to long-term inflation that would erode the value of those savings;
  2. The earning power of banks, both large and small, would come under additional pressure by suppressing the spread between what they can earn by lending at longer-term tenors and what they pay on the shorter-term deposits they take in;
  3. Pension funds would have to reassess their potential returns, with the consequence that public and private direct-benefit plans would have to set aside greater reserves that might otherwise have gone to investments stimulating job creation;
  4. Expanding the holdings of the Fed’s book of longer-term debt would likely compound the complexity of future policy decisions. Perversely, the stronger the economy, the greater the losses the Fed would incur as interest rates rise in response and the prices of those longer-term holdings depreciate. The political incentive to hold rates down might then become stronger precisely when we want to initiate tighter monetary policy. This concern, of course, would be a good news/bad news issue: The good news is that it would stem from a stronger economy; the bad is that might hurt our maneuverability and, in doing so, might undermine confidence in the Fed to conduct policy independently.

One other factor gave me pause and that was, and remains, the moral hazard of being too accommodative.”

Fisher concludes by voicing heavy concern over Chicago Fed President Evan’s and other members of the FOMC’s desire to allow more inflation as a means of encouraging demand. Fisher cites Paul Volcker, a man for whose wisdom and experience he has great respect, to explain why such a policy is dangerous and potentially damaging:

“[Volcker] reminded us that once unleashed, inflation combines with stagnation to make stagflation, the most painful of all combinations for the poor, for workers, for job seekers, for bond and stock holders and for businesses trying to navigate the economy.

His words from that article should be engraved on the foreheads of every central banker: “The siren song [of inflation] is both alluring and predictable. … After all, if 1 or 2 percent inflation is O.K. and has not raised inflationary expectations―as the Fed and most central banks believe―why not 3 or 4 or even more? Let’s try to get business to jump the gun and invest now in the expectation of higher prices later … and maybe wages will follow. … Well, good luck. Some mathematical models spawned in academic seminars might support this scenario. But all of our economic history says it won’t work that way. I thought we learned that lesson in the 1970s. … What we know, or should know, from the past is that once inflation becomes anticipated and ingrained―as it eventually would―then the stimulating effects are lost. Once an independent central bank does not simply tolerate a low level of inflation as consistent with ‘stability,’ but invokes inflation as a policy, it becomes difficult to eliminate.”

To that I say, “Amen.””

Kudos, Richard Fisher. To you I say, “Amen.”


James Groth is Research Associate


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