If one accepts the theory that the financial crisis was unnecessary due to mismanagement of monetary policy, there a few options for remedy to choose from. There have been some suggestions that monetary policy should be stripped from the central bank portion of the Federal Reserve in a way that would result in separate entities for banking and monetary policy governance. There are others who think they should be integrated for technical reasons, as management of credit aggregates impacts the ability to manage monetary policy.

My opinion of what to do about the problem of where the Federal Reserve focus lies in crisis is not so much with who is doing what, but in lack of accountability with the considerable amount of discretion that is bestowed upon the Fed. When doing the right thing is optional, we can almost count on priorities being skewed. In addition to that, the problems with monetary policy that lead to the financial crisis hurt the banks as much as it did everyone else and I can’t quite draw a logical connection between banking interests and those of monetary policy in conflict. It is true that there was a lack of appropriate focus on monetary policy during the crisis and too much on saving the banks. But I think the most important aspect of the crisis lies in missed opportunities for prevention rather than in the cure.

Suppose that in 2007 there had been a wall between monetary policy and banking, the FOMC informally decided on explicit inflation targeting of headline PCE that includes energy prices, and it took several years for some economists to convince the FOMC of the error. The outcome would have been the same – tight money and a financial crisis in response to an oil price shock – because separation of responsibilities can’t overcome incompetence and overestimation of the value of inflation fighting credibility by policymakers. It might, perhaps, lead to better qualified candidates on the Committee, as being a banker would not necessarily qualify one to manage monetary policy. But I am skeptical. Both Lacker and Bullard are economists by education, and so is Bernanke. They were all saying pretty much the same things until recently.

Now, suppose that in 2007 we had level targeting and FOMC accountability amended into Humphrey-Hawkins. Suppose that if the economy were to encounter severe disinflation and wildly accelerating unemployment, some or all of the FOMC would be removed by an automatic trigger. There is no guarantee that the crisis of 2008 wouldn’t have happened, but if it did, I believe there is a far better chance the mistakes in monetary policy would have been corrected much sooner. There would have been a plan B for when the zero bound binds. We wouldn’t be stuck with central bankers holding on to tools that worked in the past, but no longer work – they would be keeping other folks in the unemployment line company instead of running loose, wildly exaggerating the threat of inflation in the midst of a severe recession with an obvious output gap as large as the Grand Canyon. Simply put, if they don’t want to do their job in providing nominal stability, do it well, and correct their own mistakes regardless of where interest rates go, they should no longer have that responsibility so we can get people who take pride in it.

As it is, it doesn’t matter what folks like Bullard and Lacker do. They can and do have terrible ideas about monetary policy, be proved wrong in both theory and reality, and still not have to see it all the while they are guaranteed a job as they cause countless millions to lose theirs and remain unemployed for years. There is nothing that is going to fix that except for ensuring they are fired and experience the same kind of personal loss, regardless of whether their job is moved and focused only on monetary policy.

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