Members of Congress returned to Washington last week for some unfinished business. While the Democrats still control the agenda, the Republicans wasted little time in establishing their priorities.
With no budget for fiscal 2011, no continuing resolution to fund the government past Dec. 3 and no action on the Bush tax cuts that expire at the end of the year, what did the GOP decide to focus on in the lame-duck session?
Why, changing the Federal Reserve’s mandate. The 1978 Full Employment and Balanced Growth Act, better known as Humphrey-Hawkins, entrusted the Fed with maintaining stable prices and maximum sustainable employment. The GOP has decided the time is right to free the Fed from serving two masters and assign it the sole burden of delivering stable prices.
“We firmly believe that monetary policy decisions by the U.S. Federal Reserve must be free and independent from political pressures,” starts the Nov. 17 letter from the House and Senate GOP leadership to Fed chief Ben Bernanke protesting quantitative easing.
Don’t these folks have anything better to do right now? Their concern about the Fed’s short-term focus on asset prices is touching, but where were these paragons of long-term thinking when Alan Greenspan was inflating the housing and credit bubble in 2003, 2004 and 2005? (They were paying him back for his coveted 2001 endorsement of the Bush tax cuts. That’s where.)
True, some conservatives have long argued for a single Fed mandate, which, along with QE2, is a legitimate subject for public debate.
Doing Fed a Favor
The issue is one of priorities. Congress has a lot on its plate, starting with the budget and the deficit. While the Fed is a creature of Congress, lawmakers should put their fiscal house in order first.
Many Fed officials would prefer a single mandate. Bernanke came to the Fed board as a governor in 2002 as an advocate of inflation targeting. Philly Fed President Charles Plosser told reporters last week that the Fed’s mandate “should be price stability” and it is Congress’s role to determine what that mandate should be. Fed Governor Kevin Warsh, one of Bernanke’s closest confidantes and advisers during the financial crisis, expressed his reservations about QE2 in a recent op-ed.
There won’t be any pushback from the Fed on retaining its dual mandate. (The same can’t be said of the Obama administration, which opposes stripping the Fed of its marching orders to pursue full employment.) Congress, in fact, would be doing the Fed a favor.
No Real Trade-Off
The idea that a central bank can deliver lower unemployment by creating higher inflation was upended by economists Edmund Phelps and Milton Friedman, who showed no permanent trade-off in the long run. You can fool some of the workers some of the time, Friedman and Phelps argued, but eventually they realize that higher wages are a “money illusion,” that their purchasing power has been crimped by inflation.
It’s much easier for central bankers to claim that price stability is both an end in itself and a means to maximum employment when inflation and unemployment are both low. With inflation below the Fed’s target and the unemployment rate stuck at 9.6 percent right now, it’s a tough sell.
Even if the Fed had a single mandate today, Bernanke would still be doing the same thing: buying longer-term bonds to insure against deflation.
Whether deflation is a real threat is a judgment, or forecasting, call. Inflation is a lagging indicator. It may not be as easy to unwind its balance sheet or bottle up excess reserves as the Fed thinks. Market perceptions can turn on a dime.
Witness the recent rise in interest rates. On Nov. 4, the five-year Treasury note, the fulcrum of the Fed’s $600 billion of asset purchases, yielded 1 percent. Two weeks later the yield was 1.5 percent. And that’s with an economy that is still trying to get out of the starting gate.
One week of strong economic data, and the Fed won’t know what hit the U.S. Treasury market. It will be sell first and ask questions later.
Why did the GOP give the Fed’s mandate such a high priority?
“The letter was proximate to the decision” to implement QE2, says Don Stewart, spokesman for Senate Minority Leader Mitch McConnell, one of four signatories to the letter.
OK. So the coincidence of the GOP missive and a Republicans-only open letter to Bernanke, signed by economists and other luminaries, was a case of bad timing.
What do we make of the other popular explanation for why the GOP chose the lame-duck session to quack about the Fed: that they did it -- wait, sit down -- to score political points?
The Tea Party movement, the argument goes, lumps the Fed in with other government entities in the “bad” column for its role in financial bailouts. QE2 is another opportunity to solidify the populist anger at government.
There’s a third possibility. GOP lawmakers may be trying to shift the focus to the monetary authority to take the pressure off themselves.
It’s one thing to promise fiscal reforms. It’s another thing to deliver.
(Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)
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