Ben Bernanke has once again come to the rescue with another dose of financial morphine. At a recent meeting, the FOMC announced its third round of quantitative easing which, unlike the other rounds, is open-ended and will continue even after the economy picks up.
9/20/2012 @ 9:05AM
After nearly four years of ultra-low interest rates and a tripling of the Federal Reserve’s balance sheet—but with little progress on reducing the unemployment rate— the Bernanke Fed has once again come to the rescue with another dose of financial morphine.
At its recent meeting, the Federal Open Market Committee, by a vote of 11 to 1, announced a third round of quantitative easing (QE3), which unlike the earlier rounds is open-ended and will continue even after the economy picks up steam. The Fed has committed to buy $40 billion worth of agency mortgage-backed securities each month until there is evidence of substantial improvement in the labor market. Operation Twist will continue to the end of this year and the benchmark federal funds rate will be kept near zero until at least mid-2015. The sole dissenting vote was cast by inflation hawk Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond.
The key passage in the FOMC statement released on September 13, which sharply departs from earlier policy, is that “the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” That policy change reflects the influence of Michael Woodford, an economist at Columbia University, who has argued that the Fed could gain traction in a low-interest environment by clearly signaling that the federal funds rate would be keep near zero for the indefinite future, even after the recovery is in full swing.
The problem is that Ben Bernanke may be steering monetary policy over a cliff. If the brakes on monetary expansion and inflation are not firmly applied at the right moment, the Fed’s go-stop monetary policy could lead to serious stagflation.
Printing money to buy debt from government-sponsored enterprises (Fannie Mae and Freddie Mac), which are now outright state-owned enterprises, is a far cry from making productive loans through a private banking system. It’s really no different from China’s central bank providing funds to state-owned banks to lend to state-owned enterprises.
More funds will go into housing, but not because of free private markets. Investment decisions will be politicized and risk-taking will increase. Savers and pension funds will continue to suffer under negative real interest rates. And just as in China, financial repression will persist and distort the allocation of capital.
The FOMC rests its decision on the dual mandate of achieving “maximum employment and price stability.” But if it’s maximum employment that the Fed wants, it could simply tell Congress to pass a law as in the former Soviet Union and make it illegal to be unemployed. Everyone could work for the government and the Fed could print money to pay them. Wage-price controls could then be imposed to suppress inflation, just as happened under President Richard Nixon. When the controls were removed the excess supply of money fueled inflation with a vengeance and Paul Volcker was left to clean up the mess.
Printing money does not create wealth, though it may help create jobs in the short run—at the cost of inflation and a loss of economic freedom. The goal of maximum employment is a chimera. In a free society, the goal should be to expand the range of choices open to people by embracing markets and limiting government. Economic research has shown that the path to prosperity is not money creation but getting the institutions right, and thus getting prices right.
In a market system based on private property rights and the rule of law, people are free to choose, and prices reflect relative values that consumers place on alternatives. The goal of free trade or voluntary exchange is not to create jobs but to create wealth. Labor is allocated to where consumers, not politicians or planners, value the jobs most highly.
If labor and other markets are allowed to function without government intervention, there will be a tendency toward market-clearing prices, including relative wage rates and interest rates that reflect time preferences and the productivity of capital. The structure of the economy will change as consumer preferences, resource availability, and technology change—so jobs will be lost and gained in a process Joseph Schumpeter called “creative destruction.”
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