Fed Chairman Ben Bernanke was back in Princeton this past week, chumming around with his old colleagues. He seems to be on the way out. People say that he will not take a university position when he leaves the Fed… at least not for a while. He is burned out… and needs to try and sort things out.
Mr. Bernanke has been in his current position as the Chairman of the Board of Governors of the Federal Reserve System since February 1, 2006. He has been in office for a long time and he has been through more strain and stress than since that time than any other agency leader still in the government at this time. He has been through the mill.
His primary success is that the United States economy did not go into a depression as bad as the one the National Bureau of Economic Research dated from August 1929 through March 1933, a contraction of peak to trough of 43 months.
The recession we did experience, from December 2007 to June 2009, lasted 18 months from peak to trough, the longest contraction since the 1929 to 1933 experience.
Mr. Bernanke's success is that the Great Recession of 2007 to 2009 was not worse than it was.
Mr. Bernanke had one basic principle to guide him through this experience, a principle that he confirmed to himself through his research on the period of the Great Depression. That principle is that when the economy is tanking, the central bank must not err on the side of not putting sufficient reserves into the banking system. That is, the Federal Reserve should err on the side of too much monetary ease.
And, that is exactly what the Federal Reserve did under Mr. Bernanke's leadership during this time of strain and stress. Its policy -- throw as much "stuff" against the wall as possible and see what sticks.
We are now in the fifth year of the economic recovery and the policy stance of Mr. Bernanke and the Federal Reserve has not changed. The Fed is still throwing "stuff" against the wall… as much "stuff" as it can. And, maybe that is why the atmosphere stinks so much around 20th Street and Constitution Avenue N.W. in Washington, D. C.
Or maybe the stink is around 33 Liberty Street in New York City, and that is why the Board of Governors votes for the policies it does.
How much "stuff" has the Federal Reserve thrown against the wall? Well, in June 2009, the Fed held about $1,225 billion in securities held outright. This was at the start of the economy recovery.
On May 29, 2013, the Fed had almost $3,225 billion in securities held outright. The Federal Reserve has purchased $2.0 trillion of securities over this four-year period!
And the economy is still growing at a year-over-year rate of less than 2.0 percent.
In June 2009, commercial banks held about $750 billion in excess reserves. In the last two weeks of May, 2013, commercial banks averaged excess reserves of almost $1.9 trillion!
And the average effective Federal Funds rate over the past 12 months has been about 15 basis points, varying month-to-month by only one basis point. The Federal Reserve is not driving down short-term interest rates. There just does not seem to be any pressure on the money markets for short-term interest rates to go one way or another.
Money stock growth continues to be relatively high historically, the year-over-year rate of growth of the M1 money stock is around 11.5 percent, and, the year-over-year rate of growth of the M2 money stock is at about 7.0 percent.
Two things about these growth rates: first of all, the growth rates of M1 and of M2 are down from the rates they were increasing in the last three years. So monetary growth is not increasing.
But, to me, the second factor is more important. The historically high rates of monetary growth continue to come from people and businesses moving their money from short-term interest bearing assets to transaction accounts -- primarily demand deposits. There are two reasons for this. First, unemployed people or people with very uncertain economic futures are keeping their wealth in demand deposits and currency to be able to buy necessities. This is a sign of a very weak economy. Second, others are moving their funds out of short-term interest yielding assets to demand deposits because the interest that they earn on "money" type assets is yielding so little that they might as well keep the funds in demand deposits.
For example, year-over-year, small time accounts at depository institutions are down by almost 18.0 percent. Year-over-year, money in retail money funds and institutional money funds is roughly constant. Funds that used to go into these types of assets are being put in demand deposits instead. The yield on them is just too low.
With the exception of the largest commercial banks in the country, banks are not doing any kind of lending to speak of. Why is this? Well, I believe that there are three very good reasons. First, many of the "less-than-large" commercial banks have a substantial amount of loans on their balance sheets that are not performing. This is the solvency problem. Second, these banks are still facing the costs of implementing the Dodd-Frank financial reform act. Time after time, one hears that the people running the "less-than-large" commercial banks are going to have to pay a tremendous price to implement the new rules and regulations. Third, the basic business of these commercial banks is just not expanding because the economic recovery is not taking place as it has in the past. These "less-than-large" commercial banks are, therefore, not lending. The lending that is taking place is in areas that are not the "traditional" type of commercial bank loan or the "traditional" commercial bank customer. This is where alternative finance is coming into play and taking over from where the commercial banks have rested before.
The Federal Reserve seems to be above these issues. The Federal Reserve still seems to believe, as it has from the 2008 period that the problems the banking system and the economy are ones of liquidity, or the lack of it. That is what the Fed continues to throw "stuff" against the wall.
What if the problems the economy were connected with insolvency and economic transition? The solvency issue can be seen in the continuing decline in the number of commercial banks in the financial system. It is not that commercial banks are failing in the numbers they did over the past three or four years or so. It is that the commercial banking system continues to shrink as more and more "less-than-large" commercial banks merge or become acquired. I just reported that the commercial banking system is on track to decline by about 200 banks this year. The total number of banks will drop below 6,000. How is the Fed policy of throwing "stuff" against the wall stopping this? The Federal Reserve seems to have no answer for this.
And what if the U.S. economy is going through a major restructuring? I have argued that this is the current case. (See economic restructuring I and economic restructuring II.) This restructuring takes time and cannot be hurried along through aggressive monetary policy. In fact, an aggressive monetary policy might even slow it down. But the Fed only believes that more and more credit inflation will get things going again and put people back into the jobs they used to have. But the Fed seems incapable of questioning its underlying assumptions.