What Hath the Fed Wrought?


At RealClearPolicy No Labels has a post somewhat reminiscent of the analysis posts at Vox.com on the Federal Reserve. In the article five facts are highlighted:

  1. The Federal Reserve was created in 1913 by President Woodrow Wilson following the Panic of 1907, one of the worst global financial crises of the 20th century. The Federal Reserve Act, which President Wilson signed into law, established a central bank for the entire country (for the third time, but the first time successfully).
  2. The modern-day Fed was shaped by President Jimmy Carter, who signed the Federal Reserve Reform Act of 1977.
  3. During the 2008 financial crisis, the Fed helped stabilize the economy by deploying a number of tools, including cutting interest rates, providing targeted assistance to financial institutions, and buying mortgage bonds.
  4. However, not everyone agrees that the changes to the Fed since the financial crisis have benefited the American public.
  5. While Trump is not the first American president to speak out against the Fed, there haven’t been many others.

When I read that fifth point I was reminded of James Carville’s wisecrack to the effect that when he died he wanted to come back as the bond market so he could intimidate everybody.

I only have a couple of remarks. First, the present long-term interest rate is 3.19%, the highest it has been in a decade. Is the Federal Reserve succeeding in its mandate? Is 3.19% high, medium, or low? As a point of comparison in 1977 the long-term interest rate was around 8% and prior to 1977 it had been pretty stable at around 5% (roughly the average over time) for many years. My second remark is that several economists and politicians have noticed that Fed policy has been running in a direction opposite to that of federal fiscal policy for a long time. When the Federal government spends money to promote economic growth, the Fed tightens monetary policy, vitiating the effect of the fiscal policy.

Third, since 1977 the Gini index for the United States, a measurement of income inequality, increased sharply and has remained at that much higher level level ever since. The big jump preceded the income tax reform of the 1980s, the large increase in low wage immigrant labor in the United States, and the big increase in the U. S. imports of manufactured goods.

How big a factor has Fed policy been in creating income inequality in the United States?

5 comments… add one
  • Guarneri

    Wow. What a topic. About a month ago I was looking at gini coefficients on a rainy day and in response to a blog post. As I’m sure you are aware, you can come up with any number of gini calculations.

    In direct response to the query, you could start with the fact that most of the relevant western countries have experienced prolonged rises. So the answer would have to be that the Fed has had no influence. Or you could say that it is more a phenomenon of western monetary authorities, not just the Fed.

    I’ll have to come back to this – golf today. But note, (and I’m sure you have located an index showing a great rise pre-1977) but I can show you differences in the pre and post tax/transfer payments indexes. A per capita index that flattens at 1960. A household index that rises right through the mid-90’s. And academics seem to choose their methodologies and time periods rather, uh, conveniently. And so on.

    As an aside, what with the rain here Thurs and Friday I sat down and calculated the effects on stock market pricing under reasonable ranges of assumptions (NPV calculations) comparing 1,2 and 3 point rises in the discount rate, and then vs various estimates I’ve seen of the effect of trade policy on GDP/earnings growth. YMMV, but the interest rate/discount rate is probably somewhere between 4-8 times more powerful than trade, various (“Trump’s unwise trade policies”) pundits notwithstanding. In just looking at the effect of interest rates, you can ascribe about an 8% repricing for each point. You ask in the body of this blogpost if 3% is too high or low. I’ll bet market participants are asking themselves if the 10 yr is going to 5.

  • Guarneri

    This blogpost should get a list of comments a mile long. Think of the public policy issues that get attention today. Uni-gender bathrooms. Free beer schemes. The ridiculous fragile psyches of people in schools or workplaces. Whether Trump serially takes liberties with the truth like every other politician in my lifetime. It makes you want to slap people, throw their comfort dogs out and tell them to grow up.

    But what issues can tear at the very fabric of US society? Income inequality. (and some of the hairbrained proposed solutions) How about excessive immigration? How about an eviscerated manufacturing base or the fall of integrity of the press?

    What has the Fed done to exacerbate income inequality? How about betray older or less wealthy savers who all of the sudden couldn’t get historical returns on their (appropriately) more heavily weighted fixed income investments? Rather, a pittance. How about the yield chase and equity market valuations that ensued? Great if you have stock market assets because you have stock market money.

    I consider income inequality to be more of a systemic issue. But if you want to look at isolated situations. Suppose you believe the Fed really was providing banks the opportunity to re-establish reserves after the housing collapse. Benefit to bank execs and stockholders. Cheap credit for mortgages? Good if you were a speculator and won the game of musical chairs. Bad if the music stopped on you.

    I’m sure there is more…

  • CuriousOnlooker

    I wanted to comment on #5.

    There is good reason that the Federal Reserve is THE independent government agency. Venezuela is what happens when monetary policy is driven for the benefit of those who have power to the exclusion of any other interests.

    But independence from partisan interference should not absolve it from public accountability. In the last 20 years, no one in a real position to effect change has asked the following:
    1) What was the Fed’s role in the Dot Com Bubble? Was it appropriate to lower interest rates for Y2K when the economy was clearly in bubble territory?
    2) Was it appropriate for the Fed to lower interest rates to 1% in the dotcom bust; with the clear intention of stroking the housing market to compensate for the Dot Com bust?
    3) Was it appropriate for the Fed to hike interest rates in 2007 even as the housing market was already peaking and causing a recession?
    4) Was it appropriate for the Fed to do quantitative easing in 2013 when the economy was not in a crisis situation?

    That’s the problem – the Fed’s current policy maybe appropriate, but given its track record. its hard to give it the benefit of the doubt.

    Its another one of those Trump is onto something, even if he’s the wrong messanger and the way he does it is not the ideal way. But its hard; who has the credibility and power to hold the Fed accountable. The White House and Congress aren’t it; since they are two self-interested to do an effective job. Financial institutions will not do it since they are beholden to the Fed (or is it the other way around?). So you are left with cranks saying “audit the fed”. Sigh, those who can hold the Fed accountable cannot be trusted, and those who could hold the Fed accountable don’t have any power.

  • Guarneri

    “That’s the problem – the Fed’s current policy maybe appropriate, but given its track record. its hard to give it the benefit of the doubt.”

    You might want to consider reading a synopsis of Friedman and Schwartz’s Monetary History of the US. The basic thesis is that the Feds timing is chronically atrocious, adversely affecting the real economy. You should also be aware that the two principal criticisms are that monetary aggregates can get out of control due to unstable velocity or that they need help from fiscal manipulations. The latter is vintage Krugman, who never saw a fiscal intervention he didn’t like, and changes his story on an as needed basis.

  • Guarneri

    “Its another one of those Trump is onto something, even if he’s the wrong messanger and the way he does it is not the ideal way. “

    I saw a tongue in cheek, but insightful, quip recently. “Happy, well functioning countries don’t elect Donald Trump. Miserably managed ones do.” Lost on most people, especially the establishment, more progressive and NeverTrump types, is that they got fired for gross incompetence and neglect by a fed up electorate. Those folks generally don’t look in the mirror, but lash out. See: Clinton, HR.

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