Blaming The Fed For Asset Price Inflation

by: Michael Shedlock

Bloomberg is reporting Fed Blamed for Asset-Price Inaction.

Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.

Otmar Issing, former chief economist at the European Central Bank, and Stanley Fischer, head of the Bank of Israel, were among guests at the Fed's summer symposium in Jackson Hole, Wyoming, to challenge the hands-off approach. Fed Governor Frederic Mishkin reiterated his view in a paper at the conference: Officials should only respond to the effects of asset prices on the outlook for economic growth and inflation.

"The position that `this isn't an issue for central banks' has lost some support,'' Issing said in an interview at the gathering, which ran from Aug. 30 to Sept. 1. "The tide is turning.''

The criticism -- one academic paper gave the Fed an `F' for its handling of housing -- may spur policy makers to strengthen regulation of lending practices that helped fuel the three-year mortgage boom that's now unraveling. Chairman Ben S. Bernanke, 53, has promised to draft new rules by year-end.

[Mish Comment: Just what we need ... New rules by someone as clueless as Bernanke. For more on this idea please see Bernanke Proves he is a Complete Fool]

By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.

"Central banks, probably on more occasions than they would like to admit, should respond to asset-price bubbles," said Fischer, who taught economics at the Massachusetts Institute of Technology when Mishkin, 56, and Bernanke worked on doctorates there in the 1970s. Fischer, 63, also served as deputy managing director of the International Monetary Fund.

The Fed had its supporters. Allan Meltzer, author of a history of the central bank, said "regulation induces innovation to offset regulations" and endorsed the "market discipline" approach.

"There's reason to doubt that central banks can in fact identify bubbles accurately," added Meltzer, a professor at Carnegie Mellon University in Pittsburgh.

Light Touch

Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy. Mishkin, who has collaborated on research with Bernanke, said much the same in his paper: Policy makers should respond to housing swings ``only to the extent that they have foreseeable effects on inflation and employment.''

Mishkin's argument provoked a challenge from William White, head of the monetary and economics department at the Bank for International Settlements, who said the Fed should indeed "lean" against asset prices when they start to climb.

"Rick is basically saying, `We can't lean, but we can clean up,'" White said, referring to Mishkin by name and raising his voice to make his point. "I think we can make equally strong arguments for `You can lean and you may not be able to clean up.'"
The Crux of the Matter
  • Miskin is the problem.
  • Bernanke is the problem.
  • The Fed is the problem.
  • Central bankers in general are the problem.
Why is it that Miskin, Meltzer and other Fed apologists say the Fed cannot foresee asset bubbles while believing the Fed has magic powers with regard to price inflation, interest rates, derivatives, housing, education, peak oil, productivity, capacity utilization, and a dozen other things the Fed offers opinions on?

The plain fact of the matter is the Fed is the Fed has never in history met a bubble it did not embrace. Greenspan talked of irrational exuberance in 1994 but by 1999 was caught up in his own ideology and fully embraced the "productivity miracle" right at the tip of the bubble. Greenspan yet again, at the very bottom in interest rates embraced ARMs.

Meltzer: "There's reason to doubt that central banks can in fact identify bubbles accurately". Reason to doubt? What doubt is there? There is absolutely no doubt about the Fed's inability to identify bubbles correctly. Nonetheless Meltzer used that half-baked logic as a reason to support the Fed. The real question is "Can the Fed identify anything accurately?"

History suggests otherwise. This is yet another reason on the growing list of reasons the Fed should be abolished. Instead we see clear deficiencies of the Fed are being used as arguments in support of the Fed. Orwell would be proud.