Fed Monetary Policy and Ben Bernanke
If you were listening on Monday, the mainstream media was abuzz over Fed Chairman Ben Bernanke’s claim in an Indianapolis speech that the economy wasn’t recovering fast enough and that the Congress should not mettle in monetary policy.
That is not news.
As has become commonplace, the mainstream media got it all wrong. It wasn’t Bernanke’s point at all. His point was to answer 5 crucial questions about the Fed.
Who didn’t know the economy isn’t recovering?? Ordinary citizens certainly do. We don’t need CNN to tell us that.
It sounds silly, but the real news from Bernanke about the Fed is something called “communication tools”. They are the Fed’s newest weapon in the fight to meet its dual mandate of price stability and maximum employment. It is new glasnost – openness.
Fed Chairman Ben Bernanke has made that point several times in recent years. He made it again in his Indianapolis speech on 10/1/2012.
Questions Proposed and Answered by Bernanke in Indianapolis
The 5 educational questions Bernanke proposed and answered are these:
- What Are the Fed’s Objectives, and How Is It Trying to Meet Them?
- What’s the Relationship between Monetary Policy and Fiscal Policy?
- What Is the Risk that the Federal Reserve’s Monetary Policy Will Lead to Inflation?
- How Does the Fed’s Monetary Policy Affect Savers and Investors?
- How Is the Federal Reserve Held Accountable in a Democratic Society?
Though not all the questions we’d like answered, they are a pretty darned good start.
Until recently, the Fed was a black box. Nobody knew what they were doing. Bernanke has changed all that. Transparency is the order of the day. Communications has become as important to the Fed under Bernanke as their actual monetary policies!
What Are the Fed’s Objectives, and How Is It Trying to Meet Them?
The rest of us need to understand that the purpose of the Fed is to promote price stability and maximum employment. That’s it. No more, no less. It is its Congressional mandate.
Once again, Bernanke explained that in Indianapolis.
He also went on to detail some of the monetary tools the Fed has at its command to accomplish that.
Among them described are:
- Adjust direct short-term central bank lending rates
- Adjust long-term lending rates
- Treasury security purchases
- Asset-backed security purchases (quantitative easing)
- Communication tools
Other than direct short-term central bank lending rates, all the others are considered non-traditional.
We have been into non-traditional monetary policy since late 2008.
What’s the Relationship between Monetary Policy and Fiscal Policy?
Fiscal policy is commanded by the Congress and the Executive branches of government by Constitutional authority. As described above, the Fed commands the realm of monetary policy by Congressional authority.
According to Bernanke, fiscal policy are decisions about how much the government should spend, how much it should tax, and how much it should borrow. Those decisions are made by Congress in consultation with the President. That is fundamentally different from central bank monetary policy.
According to Bernanke, fiscal policy is governed by electoral politics. Monetary policy is made by the Fed’s FOMC which, by design, is NOT limited by electoral politics.
What Is the Risk that the Federal Reserve’s Monetary Policy Will Lead to Inflation?
This is a critically important question. It is one that economists have been asking ever since QE1.
If QE3 results in inflation without economic growth… then Fed monetary policy is a failure.
Bernanke does not think that will occur. His reasons:
- QE3 will not cause inflation
- Monetary policy, in general, will react quickly to inflation
It is Bernanke’s belief that should inflation occur that the Fed’s monetary tools have the flexibility to deal with it effectively in a timely manner.
How Does the Fed’s Monetary Policy Affect Savers and Investors?
The purpose of QE3 and “The Twist” is to lower long-term interest rates.
Lowering those rates, obviously, punishes long-term savers and long-term investments that many folks on fixed incomes depend on.
Bernanke says that lower interest rates for long-term debt is because of the crash of 2008 more so than Fed monetary policy. He also says that long-term savers benefit in other ways, like through increased home values and stable prices.
How Is the Federal Reserve Held Accountable in a Democratic Society?
This is a more obscure question that does not directly affect anyone other than the Fed board itself. It deals with political independence.
Basically, he said the Fed was specifically designed to be independent of the political process with research-backed 14-year terms for its board members that transcend multiple presidential administrations and congresses. A president has a 4-year term, members of the House 2-year terms and members of the Senate have 6-year terms.
Whether that successfully keeps politics out of monetary policy decisions is for the us to decide… but that is the intent.
The biggest change in the Fed in recent years is transparency. It operates more openly than ever before. New “communication tools” simply tell us how long the Fed expects its policy decisions to last.
The Fed never did that before. Bernanke feels that by doing so now the Fed can contribute to long-term stability in our economic system and free up markets and businesses to make better long-term decisions that benefit the nation as a whole.
The FOMC, which never before explained its actions in the past, now explains the reasons for its monetary policy decisions with an official statement after each meeting. That is followed by a news conference the same day by the Fed Chairman where he extensively answers reporter’s questions.
The Fed publicly releases the minutes taken during its meetings with a detailed summary of its discussions three weeks later. The FMOC also releases quarterly economic projections.
In addition, the Fed Chairman gives 4 yearly news conferences. He also publicly testifies before each House of Congress two times a year and often before Congressional committees at other times. The Chairman and members of the FOMC frequently deliver speeches, such as the one in Indianapolis, all across the nation.
The Fed’s balance sheet and that of its 12 central banks is a matter of public record and public scrutiny.
If Congress were as open as the Fed there would be less gridlock and maybe things would get done!