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

Anthony Randazzo is director of economic research for Reason Foundation, a nonprofit think tank advancing free minds and free markets. His research portfolio is regularly evolving, and he maintains a wide interest in economic policy at both a domestic and international level.

Randazzo is also managing director of the Pension Integrity Project, which provides technical assistance to public sector retirement system stakeholders who are seeking to prevent pension plan insolvency. His research focus on the national public sector pension crisis has a dual focus of identifying the systemic factors that cause public officials to underfund pension obligations as well as studying the processes by which meaningful pension reform can be accomplished. Within the Project he leads the analytics team that develops independent, third party actuarial analysis to stakeholders considering changes to public sector retirement systems.

In addition, Randazzo writes about the moral foundations of economic theory, and is currently developing research on the ways that the moral intuitions of economists influence their substantive findings on topics like income inequality, immigration, or labor policy.

Randazzo's work has been featured in The Wall Street Journal, Forbes, Barron's, Bloomberg View, The Washington Times, The Detroit News, Chicago Sun-Times, Orange-County Register, RealClearMarkets, Reason magazine and various other online and print publications.

During his tenure at Reason he has published substantive research on housing finance, financial services regulation, and various other aspects of economic policy at the federal level. And he has written regularly on labor economics, tax policy, privatization, and Turkish-U.S. political and economic issues.

Randazzo has also testified before numerous state and local legislative bodies on pension policy matters, as well as before the House Financial Services Committee on topics related to housing policy and government-sponsored enterprises.

He holds a multidisciplinary M.A. in behavioral political economy from New York University.

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