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Thursday, February 21, 2013

This is what keeps me awake nights....

Prof. John H. Cochrane, writing in the Jan. 25 issue of the Hoover Digest:
Momentous changes are under way in what central banks are and what they do. We're accustomed to thinking that central banks' main task is to guide the economy by setting interest rates. Their main tools used to be "open market" operations, that is, purchasing short-term Treasury debt, and short-term lending to banks.
Since the 2008 financial crisis, however, the Federal Reserve . . . has crossed a bright line. Open-market operations do not have direct fiscal consequences, or directly allocate credit. That was the price of the Fed's independence, allowing it to do one thing—conduct monetary policy—without short-term political pressure. But an agency that allocates credit to specific markets and institutions, or buys assets that expose taxpayers to risks, cannot stay independent of elected, and accountable, officials.
In addition, the Fed is now a gargantuan financial regulator. Its inspectors examine too-big-to-fail banks, come up with creative "stress tests" for them to pass, and haggle over thousands of pages of regulation. When we imagine the Fed of ten years from now, we're likely to think first of a financial czar, with monetary policy the agency's boring backwater.


THE Walrus said...

It has always been known that one of the Fed's primary objectives was affecting mortgage rates. Regardless, what was the alternative (obviously NGDP-level targeting, but that's for another post)? Do nothing and wait on fiscal policy? HA!

In regards to being a regulator, they were always a huge regulator. Unfortunately, if you look at the fact that the Fed's purpose is lender-of-last resort, I would say pre-crisis, they weren't large enough of a regulator. If they are the group to bailout financial institutions, they should be responsible for regulating and thus (hopefully) preventing bail-outs. Moreover, they are less so a regulator now post-Dodd-Frank.

Randall Parker said...