Is Current Fed Policy Appropriate?

Frank Shostak says NO!. See:

Should the Fed Reverse Its loose Stance

Some Highlights:

Contrary to popular thinking, loose monetary policy, which leads to a misallocation of resources, weakens the economy’s ability to generate final goods and services, i.e. real wealth.

This means that loose monetary policy not only cannot provide support to the economy but on the contrary undermines the foundations for economic growth.

The so-called recovery that Bernanke and most commentators are referring to is nothing more than the revival of various non-productive or bubble activities [emphaisi mine], which in a true free market environment wouldn’t emerge in the first place.

And

Contrary to popular thinking, loose monetary policy, which leads to a misallocation of resources, weakens the economy’s ability to generate final goods and services, i.e. real wealth.

This means that loose monetary policy not only cannot provide support to the economy but on the contrary undermines the foundations for economic growth.

The so-called recovery that Bernanke and most commentators are referring to is nothing more than the revival of various non-productive or bubble activities, which in a true free market environment wouldn’t emerge in the first place.

Alan Blinder says yes!

Contrast Dr. Shostak’s analysis with Alan Blinder’s Easing the Angst About Fed Easing in today’s Wall Street Journal.

Blinder approvingly quotes Bernanke to Senate banking Committee on Feb. 26:

The FOMC has indicated that it will continue purchases until it observes a substantial improvement in the outlook for the labor market,” he said, making it clear that no such improvement has been seen. He also asserted that “the benefits of asset purchases, and of policy accommodation more generally, are clear: Monetary policy is providing important support to the recovery.

And

Which brings me to the main point: The fundamental case for extreme monetary ease has hardly changed. Mr. Bernanke and the FOMC majority believe deeply in the Fed’s dual mandate, to keep both inflation and unemployment low. They know they are succeeding on the first but failing on the second. They also learned long ago that cutting the federal funds rate by over 500 basis points (five percentage points) was inadequate to combat the recession. Rather than give up, they opted for “unconventional” monetary policies like quantitative easing.

And:

It’s not a pretty picture. But then again, neither is unemployment lingering above 7% indefinitely. This is why Ben Bernanke and the FOMC majority keep plugging away.

Is there a way out? Here’s one thing that could help. As I have argued for some time, the Fed should reduce the interest rate it pays on the roughly $1.7 trillion of banks’ excess reserves. If it did so, banks would keep less cash on deposit at the Fed. The liberated funds would probably flow mainly into the money markets, but some would probably find their way into increased lending—which would give the economy a little boost.

Back to Shostak:

If our assessment is valid then obviously the sooner the loose stance is reversed the better it is going to be for the economy.

 Needless to say, bubble activities are not going to like this since the diversion of real wealth to them from wealth generators will slow down or cease all together [Emphasis mine].

A fall in economic activity in this case is in fact the demise of various bubble activities.

Contrary to Bernanke, we can conclude that the continuation of loose monetary policies could only lead to financial instability and prolong the economic crisis.

A  reversal of current policy is a necessary first baby step on a road to real recovery and renewed sustainable economic activity. Real recovery will only begin as resourrces are shifted away from resource consuming bubble activities back to real wealth creators.

For an Austrian critique of former Fed Board member Alan Blinder’s monetary policy framework see:

Central Banking in Theory and Practice by Alan S. Blinder

 

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