Revered Monetary Authority Slams Federal Reserve’s Inaction
Kurt Brouwer January 16th, 2008
Though the central bank in China is tightening the monetary system, here at home the Federal Reserve is getting criticized for being too tight and for its inaction in the face of the credit crunch [emphasis added]:
Anna Schwartz blames Fed for sub-prime crisis (Telegraph.co.uk, January 14, 2008, Ambrose Evans-Pritchard)
‘As rebukes go in the close-knit world of central banking, few hurt as much as the scathing indictment of US Federal Reserve policy by Professor Anna Schwartz.
The high priestess of US monetarism - a revered figure at the Fed - says the central bank is itself the chief cause of the credit bubble, and now seems stunned as the consequences of its own actions engulf the financial system. “The new group at the Fed is not equal to the problem that faces it,” she says, daring to utter a thought that fellow critics mostly utter sotto voce.
“They need to speak frankly to the market and acknowledge how bad the problems are, and acknowledge their own failures in letting this happen. This is what is needed to restore confidence,” she told The Sunday Telegraph. “There never would have been a sub-prime mortgage crisis if the Fed had been alert. This is something Alan Greenspan must answer for,” she says.
Mr. Greenspan no doubt would disagree with her, but it appears self-evident that the Fed allowed the excesses of subprime lending to go on far too long. Ms. Schwartz’ comments were a bit unusual in the cloistered world of central bankers, but she certainly has the background and experience to do so. Also, this is not the first time she has criticized the Fed.
Source: Telegraph.co.uk
Schwartz remains defiantly lucid at 92. She still works every day at the National Bureau of Economic Research in New York, where she has toiled since 1941.
Her fame comes from a joint opus with Nobel laureate Milton Friedman: A Monetary History of the United States. It revolutionised thinking on the causes of the Great Depression when published in 1965. The book blamed the Fed for causing the slump. The bank failed to use its full bag of tricks to stop the implosion of the money stock, and turned a bust into calamity by raising rates.
“The book was a bombshell,” says British monetarist Tim Congdon. “Until then almost everybody thought the free-market system itself had failed in the 1930s. What Friedman-Schwartz say was that incompetent government bureaucrats at the Fed had caused the Depression.”
It is human nature that success has many folks claiming credit while failures have no one were wants to assume blame. Nonetheless, the blame game is quite popular.
According to Schwartz the original sin of the Bernanke-Greenspan Fed was to hold rates at 1 per cent from 2003 to June 2004, long after the dotcom bubble was over. “It is clear that monetary policy was too accommodative. Rates of 1 per cent were bound to encourage all kinds of risky behaviour,” says Schwartz.
She is scornful of Greenspan’s campaign to clear his name by blaming the bubble on an Asian saving glut, which purportedly created stimulus beyond the control of the Fed by driving down global bond rates. “This attempt to exculpate himself is not convincing. The Fed failed to confront something that was evident. It can’t be blamed on global events,” she says.
That mistake is behind us now. The lesson of the 1930s is that swift action is needed once the credit system starts to implode: when banks hoard money, refusing to pass on funds. The Fed must tear up the rule-book. Yet it has been hesitant for three months, relying on lubricants - not shock therapy.
“Liquidity doesn’t do anything in this situation. It cannot deal with the underlying fear that lots of firms are going bankrupt,” she says. Her view is fast spreading. Goldman Sachs issued a full-recession alert on Wednesday, predicting rates of 2.5 per cent by the third quarter. “Ben Bernanke should be making stronger statements and then backing them up with decisive easing,” says Jan Hatzius, the bank’s US economist.
Bernanke did indeed switch tack on Thursday. “We stand ready to take substantive additional action as needed,” he says, warning of a “fragile situation”. It follows a surge in December unemployment from 4.7 per cent to 5 per cent, the sharpest spike in a quarter century. Inflation fears are subsiding fast.’
It is unfortunate in one sense that this credit crisis came so early in Bernanke’s tenure as Fed chairman. Had he been on board longer, he might have acted more decisively. So, if the comments of Anna Schwartz had anything to do with Bernanke’s turnaround then, more power to her. However, it may also be true that Bernanke can tackle the problem without worry about its causes because he is not the one getting blamed for the subprime lending mess. Instead, Bernanke’s successor, Alan Greenspan, is the one who is taking the hit.
No matter who is to blame, we believe action needs to be taken. In fact, we have felt for some time now that the biggest economic risk we face is a slowdown, not burgeoning inflation. So, we hope the Fed takes her comments to heart. For more on this, see Fed Chairman Opens Door To Lower Interest Rates and Federal Reserve Tries Again and PIMCO & Bill Gross Call For 3% Fed Funds Rate.
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