The Fed's 'Monetary Morphine'

A different kind of inflation problem

By George F. Will

Fortunately, not everything is up to date in Kansas City. Esther George, president of the regional Federal Reserve Bank here, is refreshingly retrograde regarding what less circumspect people welcome as the modernizing of the nation’s central bank into a central economic planner. She has concerns, both prudential and philosophical, about the transformation of the Fed in ways that erase the distinction between monetary policy, which is the Fed’s proper business, and fiscal policy, which is inherently political.

The basic interest rate — i.e., the federal funds rate minus the inflation rate — was negative during about 40 percent of the disastrous 1970s and the 2000s, which ended disastrously. Because today’s rate is negative, the Fed’s stimulus repertoire is reduced to “quantitative easing.” That phrase, which is how government speaks when trying not to be understood, means printing money. Except printing is so 20th century. Nowadays, the Fed gives banks digital transfusions of money to lower long-term interest rates, which result in . . .

Not much bang for trillions of bucks. With corporations holding upward of $2 trillion in cash, and 30-year mortgages at 3.5 percent, George, speaking several weeks before this week’s meeting of the Federal Open Market Committee, asked: “Is there anyone not borrowing today or purchasing a house because interest rates aren’t low enough? Do we expect that businesses will hire if their long-term rates are lower?”

Very low interest rates discourage saving, punish retirees living off interest-bearing assets and, George says, “incent people into riskier assets.” These include commodities, farm land (for the first time on record, prices of cropland in George’s district have risen more than 20 percent for two consecutive years) and equities. Fed Chairman Ben Bernanke evidently thinks that driving up the stock market will quicken the animal spirits of the affluent 20 percent who own 93 percent of equities, and this “wealth effect” will spur economic activity, eventually benefiting others. So, the interest rates Barack Obama favors are a form of the trickle-down economics he execrates.

Richard W. Fisher, George’s counterpart at the Dallas regional Fed, is “perplexed” by Wall Street’s “preoccupation, bordering upon fetish” concerning a possible third round of qualitative easing, or QE3. Financiers “have become hooked on the monetary morphine we provided when we performed massive reconstructive surgery” during the 2008-09 panic. However, “monetary policy provides the fuel” for America’s economy and “we have filled the gas tank and then some.”

George considers the Fed’s dual mandate — “stable prices” and “maximum employment” — “redundant”: Achieving the former is the best thing the Fed can do for the latter. James Bullard, president of the St. Louis Fed, seems to agree. Monetary policy, George acknowledges, is “a blunt tool.” Its bluntness is, however, a virtue if it discourages the folly of trying to fine-tune the economy.

“People,” George says, “will figure out a way to make a buck if they know what the rules are.” Investing — including hiring, which is investing in employees — is a wager on the future. Fidgety government makes the future unnecessarily opaque. Stanford’s John Taylor notes that “over the past 12 years, the number of provisions of the tax code expiring annually has increased tenfold,” the number of federal regulators has grown 25 percent in five years, and Obamacare and Dodd-Frank expand uncertainty by enlarging the government’s discretion.

Uncertainty is exacerbated by the Fed’s exercise of its vast discretion, including QE1, QE2 and, perhaps soon, QE3 (or QE5, including two “twists” also aimed at lowering borrowing costs). Bernanke, who promises more “policy accommodation” to support the economic recovery, is inadvertently vindicating Milton Friedman’s belief that “the stock of money [should] be increased at a fixed rate year-in and year-out without any variation in the rate of increase to meet cyclical needs.”

When the independent Fed buys bonds to affect short-term economic stimulus by manipulating long-term interest rates, this is less monetary policy than fiscal policy, which is the business of an accountable Congress. It also is a preposterous arrogation by the Fed of a role as the economy’s central planner, a role beyond the Fed’s — or anyone else’s — competence, and incompatible with its independence.

Bernanke’s term ends in 2014, and Mitt Romney says that he would not reappoint him. If Romney becomes president, he should appoint someone such as George, who would concentrate on protecting the currency as a store of value — restraining inflation — while reversing the recent inflation of the bank’s ambitions, which have not prevented the recovery from being dreadful and may have helped to make it so.