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Home Publications Blogs Beat the Press Why Does the Fed Have Credibility and What It Is Worth?

Why Does the Fed Have Credibility and What It Is Worth?

Sunday, 07 November 2010 22:39

The NYT repeatedly refers to the credibility of the Federal Reserve Board. This is an interesting assertion. The Fed failed about as completely as a central bank possibly could in allowing the growth of an $ 8 trillion housing bubble. According to the Fed's own projections, the collapse of this bubble is likely to lead to more than $4 trillion in lost economic output, more than $13,000 for every person in the United States.

By comparison, the costs of the inflation that it was battling in the 70s and 80s were trivial. It is difficult to see how anyone who understands economics would give the Fed any credibility whatsoever based on its track record.

Comments (5)Add Comment
written by izzatzo, November 08, 2010 7:28
The reason the Fed's credibility is constantly questioned is obvious. It's because fiat money undermines competition by creating a tragedy of the commons.

To many want free money because it's a common rather than private good where there would be tresspassing signs all around to prevent its overconsumption.

The only solution is to privatize money and have it produced by private competitors, which would stablize exchange and storage values and prevent asset bubbles.

For example, if all those houses had been bought by goldbugs with gold instead of fiat money we wouldn't be in this mess. Instead there'd just be Collaterized Gold Obligations to redeem at face value adjusted for hyper leverage as demonstrated by Gordon Liddy.
written by skeptonomist, November 08, 2010 8:05
The piece says "The portfolio of federal bonds [the Fed] amassed as a result of the 2008 crisis will swell further, just about doubling." Actually total holdings are now about $2.2T, so adding another $600B will hardly double holdings, and expecting this to have a major effect is pretty silly.
Most of the Fed's holding are not in Treasuries, so it is possible that the Treasury holdings will double by adding $600B but this is still a fraction of the Fed's balance sheet. It's not surprising that the reporter is confused, as the Fed's moves have been complex, buying and selling MBS's, agency bonds and various kinds of short-term debt. The Times itself published a graph in the last few days which apparently showed that Treasury holdings actually declined since early 2008 (sorry, can't find it again).
written by skeptonomist, November 08, 2010 8:09
The credibility that the inflation hawks are referring to is in the supposed ability of the Fed to control inflation. Those who advocate raising the inflation target also rely on this credibility, because raising the target has no direct effect at this point - people are supposed to believe that inflation will increase, and so spend and invest more. Krugman has written a lot on this in his blog and in an editorial today, but the logic still escapes me - inflation is currently lower than the target, but if the target is raised people will believe that the higher target will be met? More inflation would probably be a good thing, but there is little that the Fed can do that it has not already done.
written by DesolationJones, November 08, 2010 7:07
Credibility in context of the monetary policy only refers to meeting their inflation targets. They're not talking about general credibility of the fed. They failed at the regulation side, but that's not what is meant by credibility. But yes, they aren't credible because they haven't been meeting their 2% inflation target. Perhaps missing the bubble is part of the reason why they haven't been able to meet that target, but with enough money printing, 2% inflation should be able to be maintained even during the midst of a housing collapse.
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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.