Should the Fed Stay in Regulation?

One of the central issues in the postcrisis effort to reform our regulatory infrastructure is who should do the regulating. The answer to some in Congress is none of the above:

“… under consideration is a consolidated bank regulator, one aide [to Alabama Senator Richard Shelby] said. The idea is supported by [Connecticut Senator Christopher] Dodd, who proposed eliminating the Office of Thrift Supervision and Office of the Comptroller of the Currency, and moving their powers, along with the bank-supervision powers of the Federal Reserve and the Federal Deposit Insurance Corp., to the new agency.

“Negotiators are still deciding how to monitor firms for systemic risk, including how to define and measure it, what authorities to give a regulator and which agency is best suited to get the power, a Shelby aide said.”

It’s Not about Interest Rates Yet

Incoming data continue to support expectations that the Federal Reserve will hold rates at rock bottom levels for the foreseeable future – likely into 2011.  But interest rates should not be the focus of policy analysts.  The Fed will manipulate policy via the balance sheet long before they fall back to the interest rate tool.  The question is whether or not the slow growth environment is sufficient to persuade the Fed to hold the balance sheet steady or even expand the balance sheet beyond current expectations.  And there always remains the third option, favored by a minority of policymakers – withdraw the stimulus now that growth has reemerged.  At this point, I suspect the Fed will stick with the hold steady option. 

The Letter and the Spirit of Monetary Policy

If there was one major disappointment with Bernanke’s speech at the AEA meetings last weekend it was his choice to fight insular battles will equally insular arguments.

Part of the reason was tactics of course. Inane criticisms arguably deserve a commensurate response. So when you have somebody like (Stanford economist) John Taylor on a self-appointed mission to prove that his own Taylor rule can explain absolutely anything—from the Great Inflation, to the Greenspan put, to (coming soon!) life on other planets—, using the “enemy’s” own weapon to neutralize him is a cunning strategy.

Controlled-Burn Inflation

The following expresses my personal views, not those of the SEC or its staff.

Suppose all the Good Guys (Joe Consumer and Homeowner) are loaded with debt, and suppose that this debt is payable to the Bad Guys (Rich People and Foreigners). What can you do about it? Oh, and also suppose that the debt is mostly in nominal terms.

Answer: You inflate.

Out of the Gate with a Bang

If  you were looking for a final, cataclysmic collapse of the US economy, you remain disappointed.  To be sure, the fallout from the financial crisis is severe, with the palpable wreckage evident in the bottom line, a rate of underemployment  at 17.2%.  Yet even the most diehard pessimist could not fail to recognize the numerous signs of a cyclical turning point in the second half of 2009.  And those signs continued into the new year with today’s ISM release.  The bulls had reason to run with these numbers; the near term outlook appears baked in the cake .  Yet the near term is not an interesting question, in my opinion.  The interesting question is what will emerge in the second half of the year.  Is the first half a head fake?  And, more importantly, where will incoming data lead policymakers, particularly at the Fed?    My expectation remains that the Fed will wait until the medium term uncertainty is lifted before raising interest rates, which would be well into the back half of this year if not into 2011.  But that might not be the ball to watch; policymakers probably worry about the size of the balance sheet more than the level of interest rates.  The near term risk is that stronger than expected growth in the first half would tempt the Fed to withdraw that liquidity before the recovery became fully entrenched.

No to Bernanke

Paul Krugman’s speaking notes are here. Ben Bernanke’s are here.

Bernanke’s speech is largely a defense of the Federal Reserve’s monetary policy in the past decade, and therefore of the old Greenspan Doctrine dating back to the 1996 “irrational exuberance” speech–the idea that monetary policy is not the right tool for fighting bubbles. The Fed has gotten a lot of criticism saying that cheap money earlier this decade created the housing bubble, and I think it certainly played a role.