Thursday 16 Aug 2018 | 10:16 | SYDNEY
Thursday 16 Aug 2018 | 10:16 | SYDNEY

The GOP pines for a simpler time


Stephen Grenville

24 October 2011 09:46

There seems to be a competition among Republican US presidential hopefuls to see who can pour the most abuse on the Federal Reserve, Chairman Bernanke and monetary policy.

Front-runner Rick Perry said Bernanke would be 'almost treasonous' if he continued quantitative easing (QE) policies. At the recent debate, all candidates took the opportunity to criticise Bernanke (who, it might be recalled, was appointed by Bush, not Obama). Now Ron Paul has written a substantial piece on what is wrong with US monetary policy and the Fed. The short answer is: everything.

Money... need not and should not be managed by the government...The Federal Reserve has caused every single boom and bust that has occurred in this country since the Bank's creation in 1913.

Parts of the article are demonstrably wrong. For instance, the QE has not 'increased the national debt by trillions of dollars'.

If the US were to move to a system in which the central bank did not manage the money supply or set short-term interest rates, it would certainly be startlingly unique among world central banks. Fellow candidate Herman Cain's attraction to the gold standard is, similarly, a longing for a failed relic of the past. But perhaps these ideas are no nuttier than the all-purpose mantra that salvation is to be found by getting the government out of everything.

America doesn't elect extremist presidents, so the Fed is probably safe enough. But the fact that this mindless condemnation of the Fed goes largely without critical comment is symptomatic of the pathetic state of economic debate in the US. The handling of the 2008 financial meltdown was not flawless, and a good case can be made that Chairman Greenspan's tenure as 'maestro' of the Fed is at least partly responsible for the mess.

But these are topics for a serious debate on specific vexed policy issues: the impotence of interest rates to counter a strong recession when over-leveraging weighs on confidence; the dilemmas of 'too-big-to-fail' financial institutions; how to handle asset-price booms and the pro-cyclical nature of financial intermediation; how to balance prudential concerns with a dynamic financial sector.

US monetary policy in the current recession has been laboring under the substantial handicap that the macro instrument most relevant for these circumstances — fiscal policy — has been emasculated by political veto. Bernanke himself has readily asserted that 'central bankers alone cannot solve the world's problems'.

The true dilemmas of monetary policy, as emphasised by recent experience, have been set out in a more useful way by the Bank for International Settlements' Claudio Borio. Will persistent low policy interest rates distort longer-term price signals? Has the sheer weight of government debt (itself largely a reflection of the financial problems of 2008) distorted portfolio decisions in ways that weaken monetary policy?

Borio says: 'An overarching challenge will be to manage expectations, recognising the limitations of policy as a tool to manage the economy. Central banks were never as powerful as generally believed.' Practitioners of monetary policy have much to be modest about. But the Republican candidates are clueless when it comes to making policy work better.

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