The Economist's Ryan Avent has a compelling critique of the Fed, and timely, too, as our economic masters gather in Washington today to discuss their policies in light of the latest economic news. If reports are correct, they will decide to do nothing about worsening indicators for a few more perilous months.
Avent observes that one of the arguments in favor of this rather dismal status quo is that the Federal Reserve needs to maintain its credibility as an institution, and in particular as an inflation-fighter. Conservatives on the Fed's monetary policy committee and elsewhere fear that steps taken to accelerate economic expansion -- and create jobs -- will make it impossible for the central bank to lower inflation at some unidentified future point. (We've already discussed why this is a bad argument.)
But even as the Fed appears concerned about its future credibility, the real danger is that people will stop taking it seriously today. Given the summer spent dithering about and the likelihood of further dithering until Christmas, even as the unofficial inflation goal hasn't been met in years and slips toward deflation in a slowing economy, it's hard to take them seriously as a policy-making institution. Here's Avent's analysis:
The Fed can buy credibility and with it an end to disinflation and much of the pain of the slow recovery. But doing so would put the Fed on the hook in the event that policy fails. But if the Fed were confident that the policy wouldn't fail, it would go ahead and ante up. Mr Cowen argues that for policy to work, Americans must find a way to believe in the Fed. I'm not sure this is quite right. For policy to work, the Fed must believe in itself.
It's remarkable that we've created an independent central bank so that it can take major policy action free of any concerns other than what is best to keep prices stable and employment high, and see it fail for fear of doing anything.
-- Tim Fernholz
