Searching for a way to put pressure on Alan Greenspan not to raise interest rates before the election, the Wall Street Journal editorial page finds one Melvyn Kraus of the Hoover Institution, author of How NATO Weakens the West. Kraus attacks Greenspan for:
WSJ.com - Irrationally Active: rais[ing] interest rates last week and signal[ing] more hikes are on the way in the midst of an unquestioned economic slowdown, and ahead of sensitive national elections...
What is the source of Greenspan's problems, according to Kraus? It is that Greenspan pays attention to economic conditions and forecasts when he makes monetary policy:
[W]hat's making U.S. monetary policy so unstable in the past year -- waiting too long to get started with interest rate hikes and now being relentless on the ascent -- is that the Federal Reserve keeps changing its mind which "bad" it needs to correct. First it was recession. Then it became deflation. Now it's inflation.... And this too can change if, for example, the Fed was to become convinced that the present economic slowdown is more than temporary. It is not inconceivable that within a few months the Fed's most recent statement that "the economy nevertheless appears poised to resume a stronger pace of expansion going forward" will look every bit as silly as last year's statement about needing a "firebreak" against deflation.... Monetary activism has allowed this yo-yoing of Fed concerns to destabilize U.S. monetary policy....
But last year's statement does not look silly. The Federal Reserve makes its decisions by thinking about what condition the economy is likely to be in a year from now--for it takes a year for its policy moves to have their impact--and trying to take action now to guard against risks and dangers. A year and a half ago, deflation was indeed the most serious possible future danger to guard against. Now Greenspan thinks that inflation has become enough of a danger that the extremely stimulative monetary policy of the past year is no longer warranted. (I think he's wrong, but he has a better track record at this than I do: his policy is not silly.)
Kraus wants to junk this tuning of interest rates in response to economic conditions: it's bad to lower interest rates in a recession; it's bad to lower interest rates because your models predict a possibility of deflation; it's bad to raise interest rates when your models see inflationary pressures about to start building--especially "ahead of sensitive national elections."
What does he want to replace current Federal Reserve policymaking with? He doesn't say. He might be in favor of a stable money-growth rule--but that produces wild instability in interest rates. He's definitely opposed to inflation targeting, whether formal or informal. the only positive thing he will say is that the European Central Bank is good, and should not change:
Critics of the European Central Bank argue that it should be a more activist institution, like the Federal Reserve in the United States, that uses monetary policy to moderate real economic activity as well as inflation....
[...]
Even if the ECB's Governing Council changed its mind as often as the Federal Reserve, its antipathy to monetary activism would prevent wildly swinging monetary policies. This is a major advantage of the European system... Why any European -- and there are many in the government, media and universities -- would want to adopt the American monetary system, whose philosophy of monetary activism promotes unstable monetary policies which can do more harm than good, is beyond comprehension. The ECB does not try to negotiate every wiggle in the business cycle -- and the Europeans are much better off for it.
Perhaps because the Volcker-Greenspan Federal Reserve has been a lot like NATO--an extraordinarily successful social institution, doing an extremely important job very well, and making the world a much better place?
Posted by DeLong at August 18, 2004 05:40 AM | TrackBack | | Other weblogs commenting on this post" more hikes are on the way in the midst of an unquestioned economic slowdown"
Unquestioned economic slowdown? I thought our economy was strong and getting stronger? The best economy in 20 years!
I guess Kraus has been listening to those pessimist Democrats.
Posted by: Kuas on August 18, 2004 03:55 PMLet's see. In 1998 there is a potential financial crisis, and a potential bubble. Fed can't ease and tighten at the same time, so choose one, hope the political leadership will deal with the other. Since global financial meltdown is much more up the feds alley and is a closer problem - lower rates, and fret publically about the bubble, hoping the elected leadership does something.
Oh well. They don't. Raise to deal with potential inflationary pressures, pops the bubble and starts a recession. No big deal, the Fed is supposed to start recessions, and the political leadership can blame the fed for the pain and then use this to fix the structural problems with the economy.
Oh well. They don't. Ease rates to the floor to keep the economy propped up, fret about budget deficits and "external imbalances". That's devaluation. Hope the political leadership takes the opportunity to inject useful fiscal stimulus before devaluation starts pushing commodity prices up and threatens inflation.
Oh well. They don't. Start raising rates slowly in search of a soft landing and taming of inflationary pressures. Fret about the soft nature of the economy, warning the political leadership that they need to do something about deficits.
I'm not a big Greenspan fan, but he does seem to be facing the choices available and making them. It's not his job to force unpleasant choices, its his job to forestall them. That the political leadership has consistently failed to do so is not his fault.
Posted by: Stirling Newberry on August 18, 2004 05:13 PMIsn't it more difficult for the ECB to adopt the same active approach as the Fed because conditions across the EU are less uniform? Haven't there been contradictory actions needed in different countries of the EU? I seem to recall reading that being able to move to where the jobs are is important too, and this must be harder in Europe than here, despite unification.
Posted by: John Stein on August 19, 2004 08:01 AM