Am I Going Too Easy on the Fed?
by Neil H. Buchanan
Two weeks ago, when former Federal Reserve chair Ben Bernanke won this year's faux-Nobel in economics, I wrote: "How Did We Luck Out at the Fed?" Bernanke had always been a reliably orthodox conservative economist, with all of the standard credentials that would make him an obvious choice by a Republican president to run the nation's central bank. When George W. Bush tapped Bernanke in 2006, the choice was not depressing but certainly counted as uninspired. My column, however, argued that Bernanke had ended up being a brilliant Fed chair.
History sometimes confronts people with opportunities for greatness or catastrophic failure, and the global financial crisis of 2008-09 allowed Bernanke to prove that he was neither a hack nor an ideologue. That was our good luck, because there are plenty of people who have served in that position (and others who were surely on Bush's short list when Bernanke was chosen) who would have made horribly wrong decisions. It took a truly bold mind to violate hard-money orthodoxy by pouring money into the economy when it absolutely needed it -- even as the usual suspects were screaming about currency debasement and all the rest -- and to keep interest rates at or near zero for years on end. To the extent that we have had any economic success in the last sixteen years -- and we have, although it has been far too unequal in its effects on real people -- it all began with Bernanke.
I wrote my column two weeks ago to note that the Fed has been a haven of sanity in an increasingly degraded policy and political environment in the US. In 2014, after Bernanke had served two full four-year terms, Barack Obama replaced him with Janet Yellen (now Joe Biden's Treasury Secretary), and Donald Trump then replaced her (because everything Obama-related had to go) with Jerome Powell, who still serves as Fed chair today.
But has the Fed truly been as good as I claimed in my recent column? And even if the answer to that question is yes, is the Fed making a mistake now? If so, the Fed might be needlessly dooming millions of Americans (and people in other countries, for that matter) to lose their jobs, their houses, and possibly their families. Sadly, I think the answer is yes. The Fed might feel that it has no choice but to slam on the brakes to try to reduce inflation, in the tough-love kind of approach that monetary policy types always applaud, but it might end up simply inflicting pain gratuitously.
That does not necessarily mean that Powell and the other Fed policymakers know that they are causing pain with no gain, which means that when I say that they might be "simply inflicting pain gratuitously," I am not saying that they are being deliberately callous. They might simply be wrong. But they do know that they are causing pain. The only question is whether they are right that it will have been worth it.
Again, I am not so sure.
Generally speaking, it is somewhat uncharacteristic of someone like me to cheer for the Fed. There is a long tradition of left-populist criticism of the Fed, derived in large part from what makes our central bank so effective: its political independence. The Fed can take unpopular actions, and as long as its actions are not so unacceptable as to cause a political upheaval in which politicians would risk dismantling the Fed's political guardrails, it will get away with it. It is not as extreme as the Supreme Court's ability to mangle the Constitution, subject only to the amendment process (or a political effort to change which people serve on the Court, and how many of them do so at any given time), but it is close.
And because the selection process for the non-Chair positions at the Fed that have voting power or that control other policy levers has always favored business interests -- most obviously the financial sector -- being a liberal who defends the Fed is a bit of a queasy experience. Wall Street generally does run that show, and I am no fan of Wall Street. What gives?
In the face of increasing right-wing craziness in the last decade or so, many people (not just progressives like me, but centrists and even some conservatives as well) have wondered how the money men feel about the Tea Party and its progeny. In my writing about the debt ceiling, for example, I have lost track of how many times I have asked in one way or another how the people who count on financial and economic stability are feeling about people (their political allies, to be clear) who want to burn the system down to the ground.
While the Fed's impressively effective insulation from political pressure can -- and generally does -- cause it to choose policies that people on the left oppose, it also allows the Fed to frustrate the firebrands on the right. The enemy of my enemy is not always my friend, but at least the Fed is set up so that it ignores the people who want to bring back the gold standard or something even crazier. Having someone like Bernanke in charge (and there was always someone pretty much like Bernanke in charge) meant that I would never be happy, but at least the nihilists on the right would never be able to ruin everything.
The most famous case of the Fed steering way out of its lane was in 1972, when Richard Nixon's appointee as Fed chair, Arthur Burns, pumped up the economy in an obvious effort to support his patron's presidential reelection bid. But that deviation had the salutary effect of making the Fed's culture even more politics-resistant in subsequent years, which in general is a good thing. Presidents find it useful to rail against the Fed (especially because they inherit Fed chairs from their predecessors) but not to do anything about it. One of the only ways in which Trump acted like a normal president was, in fact, that he complained bitterly that Powell was being too restrained in his monetary policy, because Trump wanted him to help win the 2020 election.
The fact is, of course, that Powell was soon faced with a crisis at least as challenging as Bernanke had faced in 2008 and afterward, when the emergence of Covid-19 caused an economic upheaval of historic proportions. Powell & Co. were simply amazing in handling that crisis, so much so that this is the kind of heroic action that no one appreciates because the policymakers successfully stopped the disaster from happening. We will always think of 2020 as a very bad time, and some of us will remember that the economy was hit hard, but there was no meltdown. That did not not-happen by accident.
Even people like me, then, have had reason to trust the Fed in recent decades. The people who run the place are still ideologues, but it is a kind of ideology that is at least reality-based and does not lend itself to extremism and hostage-taking.
When inflation became a big political issue last year, I was among those who did not think that it was caused by loose money. I was hardly alone, and the most famous member of "Team Transitory" (the group that believed that inflation's uptick was caused by non-monetary shocks) was Paul Krugman. Krugman is reviled on the right for his left-leaning politics, but on economics, he is much more orthodox than I ever could be, and he made a good case that even orthodox economic reasoning did not justify Fed tightening.
As time passed, however, inflation did not come down. It did stop rising, but it has been stuck at around eight percent at an annual rate for many months. Krugman eventually announced that he had reassessed the world in light of new evidence, and he reluctantly agreed that it was indeed time to inflict some pain to cool off the economy. As always, the idea is to calibrate the tightening to get rid of the problem without tipping the economy into recession, and although Krugman and others acknowledged that an outright recession is becoming a bigger risk, they believe that the persistence of inflation left the Fed with no choice.
In general, I have gone along with all of that. In multiple columns over the last few months, I have said that the Fed was probably overdoing it, but the distance between me and Krugman was all but rhetorical, and the distance between Krugman and the orthodox conservatives on the Fed was essentially a friendly spat.
The problem is that we now have seen the Fed very aggressively tighten policy for most of the last year, but inflation is still not budging. Earlier this month, The Guardian published a piece suggesting that maybe the tight-money policy is not helping at all: "Latest US inflation data raises questions about Fed’s interest rate hikes," with the sub-headline: "Experts say raising rates ‘isn’t working’ and that the real culprits are corporate pricing, energy costs and supply chain."
To be clear, I think that Powell and his cohorts truly had no choice, as a practical matter. Yes, I emphasized above how insulated the Fed is from crass politics, but this is a different issue. Once the conventional wisdom had taken hold, the Fed could not defy so much gravitational pull. Krugman's groaning conversion was the tipping point, and if the Fed had sat on its hands, that could have led to something spectacularly bad.
Even so, I was one of the people who had, from the beginning of this latest inflation debate, suggested that the non-monetary explanations were real. The Fed consensus is driven mostly by neoliberal reasoning, which among other things dismisses the importance of corporate power, using brilliant zingers like "What? Corporations weren't powerful and profit-hungry before now?" to suggest that it is not even logically possible for price increases to be caused by anything other than loose money. I ridiculed that reductive reasoning in a Verdict column earlier this year, and for good reason.
The piece in The Guardian essentially returns to those alternative explanations for the initial rise of inflation that had been offered by left-leaning Fed critics in 2021. The argument is the flip side of Krugman's "I thought it was non-monetary stuff like supply-chain problems, but this has been going on for too long to continue to believe that story." Fed critics are saying: "You've been choking the economy for a year, but it's not having any apparent success. Why keep pounding our collective head against that wall?"
It is not quite a matter of saying that "the beatings will continue until morale improves," but it is close. Perhaps an apt metaphor would be to say that the Fed is bleeding the patient but has not cured the disease -- yet it now announces that it must open up a few more veins?
Again, the Fed might be stuck, having no real choice but to validate the hawks who tend to dominate the conversation. It might not, however, be necessary to do it so aggressively. Powell is apparently worried about regaining that ever-elusive "credibility" that central banks need, and because of his track record, I tend to trust him.
Even so, as the title of this piece suggests, I understand that I might have gone soft. It is indeed possible that inflation rose in 2021 and has not fallen since then because of problems that simply do not respond to hikes in interest rates. The Fed has one policy lever, and it has decided that it will keep raising rates as long as it keeps seeing inflation -- and probably for a good while after that (to look tough and serious). At some point, a sufficiently strangled economy will experience falling prices, but that will not be proof that this was the best way to make that happen.
It does mean, however, that the neoliberal consensus is doing what it always does: guaranteeing that the people who are least able to withstand the pain are the ones who will be forced to endure it. It is not crazy to think that some level of such pain truly is unfortunately necessary, but the empirical case for that belief is getting weaker, not stronger. Meanwhile, worries about a possible recession grow. And in this political environment, do we even need a reminder of what that could cause?