The Fed’s Dirty Easy Money

While the GOP met in Tampa, titans of finance flew to Wyoming

By Niall Ferguson

Which mattered more to you last week: the Republican National Convention in Tampa, or the Federal Reserve’s annual economic-policy symposium in Jackson Hole, Wyo.?

If you’re just managing to get by, then it was the former. In his barnstorming speech, Paul Ryan nailed it again: “The issue is not the economy that Barack Obama inherited ... but this economy that we are living. College graduates should not have to live out their 20s in their childhood bedrooms, staring up at fading Obama posters and wondering when they can move out and get going with life.”

Direct hit.

But if you’re one of the fortunate few who manages anything above $100 million in financial assets, it was Jackson Hole you were watching, for any sign of fresh monetary stimulus from Fed Chairman Ben Bernanke.

Everyone knows about the fiscal cliff of spending cuts and tax hikes that the United States is going to hit at the end of this year, barring some miraculous bipartisan agreement. But could there also be a monetary cliff?

The Fed has thrown a lot at our ailing economy. It has slashed interest rates to near zero—and promised to keep them there until 2014. In the wake of the Lehman Brothers bankruptcy, it bought all kinds of toxic assets to avert a chain reaction of bank failures. “Quantitative Easing 1” was followed by QE2 (purchases of Treasury securities), resulting in a cumulative threefold increase in the monetary base. Bernanke’s most recent gambit was “Operation Twist” (exchanging short-term for long-term Treasuries).

If the Fed’s mandate were to juice the stock market, Ben Bernanke would get an A. Since the last Jackson Hole meeting a year ago, the S&P 500 is up nearly 22 percent. But since the Fed’s mandate is to achieve price stability and full employment, the grade is B- at best. True, inflation is—officially at least—around 2 percent. But unemployment is stuck at 8.3 percent. If I’d bought assets worth nearly $2 trillion, I’d be a tad disappointed by that.

The Fed is in a hole—a Jackson Hole. Some members of the Fed’s Open Market Committee want to keep digging by providing the “additional monetary accommodation” that traders have been craving for months. They point to the latest Fed Beige Book, which reveals an economy that is still limping. But if the main effect of QE3 would be to boost the stock market, not employment, can it really be justified? More importantly, can the Fed be seen to be injecting yet more stimulus so close to an election?

The Jackson Hole symposium is one of the highlights of the wonk calendar, and I am sorry I had to miss this year’s. Back in 2005, U of Chicago’s Raghuram Rajan gave a paper titled “Has Financial Development Made the World Riskier?,” which presciently warned that bankers were “flirt[ing] continuously with the limits of illiquidity” and that “we should be prepared for the low probability but highly costly downturn.” This year’s hit paper was published ahead of Jackson Hole: William White’s “Ultra Easy Monetary Policy and the Law of Unintended Consequences.”

Get this: “Ultra easy monetary policies have a wide variety of undesirable ... unintended consequences. They create malinvestments in the real economy, threaten the health of financial institutions and the functioning of financial markets, constrain the ‘independent’ pursuit of price stability by central banks, encourage governments to refrain from confronting sovereign-debt problems in a timely way, and redistribute income and wealth in a highly regressive fashion.”

Amen. Monetary policy alone is not a sufficient remedy for our economic ills. All central banks have done, White argues, is “to buy time” for governments: “If governments do not use this time wisely, then the ongoing economic and financial crisis can only worsen as the unintended consequences of current monetary policies increasingly materialize.”

Of course, this is not the kind of technical language you can use at a party convention. At Tampa last week, delegates had to humor Texas Rep. Ron Paul with a gold- standard commission to investigate restoring the dollar to a “metallic basis.” This is an idea that appeals only to those who know no economic history. The smart position is Paul Ryan’s—that the Fed should focus solely on price stability and not attempt to print its way to full employment.

The combination of Ryan’s speech and White’s paper made last week an inspiring one. The Fed has bought us time. Now we need an administration that understands, as Paul Ryan does, just how little is left.