The day after the Federal Reserve decided its future, it met to consider its past.
No fewer than 10 of the Federal Open Market Committee’s 17 members travelled to Jekyll Island, off the tidal marshlands of southern Georgia, to celebrate the 100th anniversary of the “strangest, most secret expedition in the history of American finance”.
Unlike the 1910 group of politicians and millionaires, whose week of plotting on Jekyll created a blueprint that became the Federal Reserve, the modern Fed did not pretend to be “duck hunting”.
Chairman Ben Bernanke and former chairman Alan Greenspan were not heard to call each other “Wilbur” and “Orville”, for secrecy, as two of the better-known worthies did in 1910.
This Jekyll conference on the Fed’s history was a relaxed occasion. With the Fed’s new, $600bn programme of asset purchases agreed on Wednesday, there was little of the tension present at the Fed’s last two big conferences, in Jackson Hole, Wyoming, in August, and Boston, Massachusetts, at the start of October.
But there was still plenty for policymakers to chew on because the Fed’s history – or the interesting parts of it at least – is a history of mistakes and the subsequent effort to redeem them. How those mistakes were made carries useful lessons for the present.
The Fed made its greatest errors during the Great Depression. One was the infamous Real Bills Doctrine, under which the Fed would only lend against commercial paper that financed inventories or trade rather than real estate or financial assets. That led the Fed to reduce the money supply in recessions, when the number of such bills declined, and to mistake low interest rates for easy credit conditions.
The question is why it took the Fed so long to realise its mistake: after the depression monetary policymakers congratulated themselves on a job well done. Charles Calomiris, professor of financial institutions at Columbia Business School, suggested that part of the reason was rapid growth and economic change, with the spread of innovations such as radio, aviation and skyscrapers, which made it hard to learn about the effects of monetary policy. “Learning is slow when you need it most. Volatile times can make learning and accountability harder,” said Mr Calomiris.
Applying the same logic to today, he said: “Is it obvious whether QE2 is now warranted?”. QE2 is the nickname for the Fed’s new round of monetary stimulus, or quantitative easing. Occasions when the Fed was pushed into fiscal policy because Congress was unwilling to act, thus risking its independence, also resonate today. For example, the Fed was reluctant to be left “holding the bag” on Mexico in 1994, after Congress refused to authorise a package of loans, noted Marvin Goodfriend of Carnegie Mellon University.
The Fed is in a similar situation now. It could lose money on the mortgage-backed securities that it bought during the financial crisis or on QE2 if it has to raise interest rates rapidly in the future.
“If the Fed is going to put things on its balance sheet I think it’s incumbent on the US Treasury to take the Fed out [of the risk],” said Mr Greenspan. “The Fed should not be asked to keep that stuff on its balance sheet and in so doing create . . . political threats that I think are self-evident.”
Mr Bernanke, himself a noted student of the Great Depression, channelled two great thinkers of the past to justify the Fed’s actions today.
Walter Bagehot, who set out what a central bank should do in a crisis during the 19th century, “would have been happy with what we did”, Mr Bernanke said, while QE2 was what Milton Friedman, the economist, “would have us do”.
Mr Bernanke argued that QE2 is not so different to the Fed’s actions in the past. “This sense out there that quantitative easing or asset purchases is some completely far removed, strange kind of thing and we have no idea what the hell is going to happen and it’s just an unanticipated, unpredictable policy – quite the contrary. This is just monetary policy,” Mr Bernanke said.
In substance that may be true. But Mr Bernanke will be acutely aware that history has not always been kind to Fed policymakers who did what seemed to be obviously correct to them at the time.
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