Operation Twisted

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Written by Dean Baker   
Wednesday, 21 September 2011 20:31

The Republican congressional leadership took the unusual step of sending Federal Reserve Board Chairman Ben Bernanke a letter warning against "additional monetary stimulus."This drew an outraged response from many Washington pundits, although for the wrong reasons.

Many in the pundit class expressed outrage that politicians would dare to influence the policy decisions of the "independent Fed." This is the high priest theory of central bankers. In this worldview, the Fed and other central banks are run by people who get the truth directly from the economy and make their judgements after carefully meditating on the latest economic data and connecting it to the sacred texts of the economics profession.

The high priest theory always warranted ridicule, but after the economic collapse of 2008 no self-respecting person should ever be associated with this view. The housing bubble that wrecked the economy was cleaarly visible from at least 2002. If the central bankers had any superior knowledge of the economy, they would have been shooting at the bubble at that point rather than allowing it to grow large enough so that its collapse would wreck the economy.

Note that shooting at the bubble does not mean raising interest rates. Note that shooting at the bubble does not mean raising interest rates [corrected -- thanks Sandwichman]. (Sorry, I had to say that twice for the economists who might be reading this.) It meant first documenting the bubble, showing that house prices had grown far out of line with historical trends and with rents. This information should have been at the center of every public appearance by Greenspan and other Fed officials. The Fed also should have used all its regulatory authority to crack down on the fraudulent mortgages that were being issued.

Only if these measures had failed to stem the growth of the bubble should the Fed have raised rates. Leaving rates low was the right call because the economy was quite weak in 2002-2004. The reason for the weakness was that it is hard to recover from a collapsed bubble. The downturn following the collapse of the stock bubble was quite long-lasting, which should have made Greenspan more concerned about the unchecked growth of the housing bubble.

But Greenspan and other Fed officials (including Bernanke, who was a governor at the time) just ignored the bubble. It was the same story with the European Central Bank and the Bank of England. This was as big a mistake as it is possible for a central banker to make. All of the economic pain that we are now suffering can be attributed to this incredible failing of our central bankers.

This very recent history should be enough to tell the remaining adherents of the high priest theory of central bankers to get lost. It is absolutely appropriate for would be and actual elected officials to express their views to the Fed. In this respect it should be treated just like any other regulatory agency. Members of Congress express their views to the Federal Communications Commission, the Food and Drug Administration and other regulatory bodies all the time.

There is no reason whatsoever that they should be any more reluctant to express their views to the Fed. It is especially appropriate that they do so in a public forum where their arguments can be evaluated by the larger public.

Speaker Boehner and the rest of the Republican leadership owe no apologies for sharing their views with Chairman Bernanke and the rest of the governors. The cause for outrage is the nature of these views.

They are upset about the prospect of "additional monetary stimulus." What exactly does this mean? They don't make the argument that some Fed bank presidents have made, that another round of quantitative easing or comparable measures can lead to inflation. Rather they say it could cause "uncertainty."

It's a bit hard to understand what the nature of the uncertainty is that the Republicans fear. Will stores in Ohio and Kentucky cut back their hiring because they are unsure of Bernanke's plans for future quantitative easing?

It is hard not to get the impression that the Republican leadership is primarily worried that additional monetary stimulus could create more jobs. And that this could have the disastrous consequence of improving President Obama's re-election prospects. This is indeed Operation Twisted.