There are no longer any doves at the Federal Reserve. They have all capitulated to the call for normalisation of monetary policy – a desire that puts technical considerations above growth and employment goals
The big topic in monetary policy circles these days is the impending normalisation: how to unwind quantitative easing and bring the size of the Federal Reserve’s balance sheet back to a normal, pre-Crash level.
This is from the Federal Open Market Committee’s April minutes: ‘Participants generally agreed that starting to consider the options for normalisation at this meeting was prudent, as it would help the Committee to make decisions about approaches to policy normalisation and to communicate its plans to the public well before the first steps in normalising policy become appropriate.’
Professor Alan Blinder, a former Fed governor, wrote in the Wall Street Journal this week: ‘The FOMC will have to figure out how and when to exit from two main policies: its near-zero interest rates and its bloated balance sheet.’
In this discussion, the debate is between those who want to normalise now, and those who want to normalise later. There is no debate about why the Fed should normalise policy; normalisation as a compelling policy desideratum is just a given. In other words, normalisation is being prioritised over less important policy goals such as growth and employment.
The performance of the economy, and the ability of the economy to provide remunerative employment to the American labour force, are to be subordinated to a technical objective for ‘good housekeeping’ reasons. The Fed’s balance sheet is ‘bloated’, and that is unattractive.
This way of thinking is nonsense. First of all, how does anyone know what the optimal size of the Fed’s balance sheet is without reference to desired macro policy outcomes? Is there an optimal balance sheet independent of desired policy outcomes? Of course not. Who in the world cares how big or small the Fed’s balance sheet is?
Second, the bigger the Fed’s balance sheet, the smaller the national debt, which is good for our nation’s credit. Federal debt held by the Fed is extinguished unless and until the Fed sells it back to the public. Why would the Fed want to sell it back to the public when it doesn’t need to, and when doing so might be contractionary?
Thirdly, if the Fed’s balance sheet is indeed bloated and must be reduced for some reason, why not simply have the Fed forgive most of its holdings of Federal debt? Since the Fed is owned by the Treasury, the forgiveness of the Treasury’s debt would be ‘eliminated in consolidation’ as the accountants say: a meaningless book entry.
Oh, but that would reduce the Fed’s ‘capital’, the ignorant would argue, entirely missing the fact that the Fed prints dollars and doesn’t need a penny of capital, and that the goodwill value of the licence to print money is infinite, and thus the Fed cannot be insolvent in dollar terms.
But to return to Planet Earth: only a fool would subordinate the Fed’s statutory mandates to the shibboleth of ‘balance sheet normalisation’. QE had the effect of creating massive excess reserves. In the event that at some point these excess reserves started leaking into the money supply (which looks doubtful), the Fed has many tools to limit the impact, such as increasing required reserves or open market operations.
The bottom line is that there are no longer any doves on the FOMC. They are all Austrians now, to paraphrase Richard Nixon. The doves have all capitulated to the siren song of normalisation. Like the Fed of the Hoover years, technical concerns will subordinate such trivial matters as growth and employment: above all, the Fed must keep a tidy balance sheet.
The fact that every prediction made by the hawks since the Crash has proven false does not diminish the allure of their comfortable useless conventional wisdom.
Christopher T Mahoney is a former vice chairman of Moody’s. This post first appeared on his Capitalism and Freedom Blog
