By Paul-Martin Foss
The financial media is abuzz with speculation about what the Fed will do next, and whether it will decide to hike the federal funds rate target at its April Federal Open Market Committee (FOMC) meeting. There is a lot of speculation too as to what the Fed might do in the event of another recession or financial crisis. Some recent articles at the Brookings Institution delve into that possibility. And what is the first potential policy action discussed? Negative interest rates.
Ben Bernanke was the first to bring it up, with his first article in a series on "What Tools Does the Fed Have Left?" Although Bernanke mentioned that the Fed might return to quantitative easing also, he speculated that the Fed might even consider negative interest rates before more QE. Perhaps not surprisingly, Bernanke was more worried about whether the Fed has the legal authority to introduce negative interest rates than with the practicality of negative interest rates. His overall assessment is that "a policy of modestly negative interest rates might be a reasonable compromise between no action and rolling out the big QE gun."
Brookings also held a conference last week to discuss some of the Fed's possible policy options. Among those discussed were:
1. Negative interest rates - We've critiqued negative interest rates here and here. The only good thing about negative interest rates in the US is that they are still only under discussion. By the time they become a serious policy proposal, there will hopefully be enough negative feedback from Europe and Japan regarding negative interest rates there that it will scuttle any attempts to take them seriously as a policy tool in the US.
2. Prescriptive forward guidance - The idea that the Fed can enhance policy effectiveness by stating in exact detail exactly what it plans to do at certain points in the future. Of course, this assumes that the Fed sticks to what it says it is going to do, and doesn't change its plans in response to unanticipated economic shocks. The likelihood of that happening is slim.
3. Price level targeting - The Fed would manipulate interest rates to target the price level at a certain level.
4. Nominal GDP targeting - The Fed would manipulate interest rates to target the nominal dollar value of the gross domestic product, picking a certain growth rate, say 3% annual growth.
5. Raise inflation target of 2% - The Fed might choose to target an annual inflation rate of 3% or 4%, choosing to overshoot the 2% mark for a certain period of time in order to stimulate the economy.
6. Helicopter money - This is pretty much what it sounds like, just creating money and spreading it around willy-nilly, not through the usual means of open market operations or quantitative easing. How the Fed would actually do this and whether they actually have the legal authority to do this is a matter of debate.
Each of these ideas is probably worth a full-length article explaining just why they are so wrong, which is more than we can do here. But the central idea underlying each of these proposals is a belief in the ability of central banks to guide and direct the economy through the manipulation of prices. No matter how well thought-out the Austrian economic theory that points to central bank manipulation as the cause of the business cycle, no matter how well that theory conforms to the reality of recessions and financial crises, the central bankers and their intellectual defenders will not relinquish the view that central banks are the white knights rushing to the rescue whenever something goes wrong. To them, inflation and recession are creations of the market process, endogenous to the system, and the Federal Reserve must be ever at the ready to combat them. The idea that inflation and recessions are caused by the Fed itself is anathema to these people.
Sometimes it feels like we're banging our heads against a wall over and over again trying to point this out. But while we may never manage to convince the central bankers of their own wrong-headedness, the average man on the street seems to have a better understanding. If enough people begin to understand, hopefully they can put enough pressure on legislators to end the Fed once and for all. Let's just hope that the Fed doesn't completely destroy the economy in the meantime.