There probably isn’t much difference between me and Caroline Baum of Bloomberg; and I mean that in the way of qualifications to write about economics. In substance, however, there is a huge gap in opinion between us.
The latest article by Ms. Baum that Bloomberg published starts out this way:
Ever since the U.S. Federal Reserve lowered its benchmark rate almost to zero and embarked on a series of large-scale asset purchases, Chairman Ben Bernanke has been using his pulpit to explain how it all is supposed to work.
In a nutshell: The Fed buys risk-free Treasury securities, depressing the yields. The public is goaded into buying riskier assets, such as stocks and corporate bonds, sending those prices higher. Businesses financing themselves with equity have more money to invest. Consumers feel wealthier and spend more.
Whenever I hear the bit about risk-taking, I wonder what the dividing line is between encouraging higher asset prices and creating froth in asset markets. How does the Fed know when asset prices have gotten out of whack?
Then there was the experience of the 1970s, where monetary stimulus went into commodity prices and from there to goods and services prices, giving us “the great inflation,” Bordo said. Or it can happen in the stock market, with equity prices rising faster than can be justified by fundamentals.
Froth in markets, asset prices out of whack and the “Great Inflation” all in just a few paragraphs. And for the cherry on top, Ms. Baum continues:
In a speech last week, Fed Governor Jeremy Stein described what he said was “a fairly significant pattern of reaching-for- yield behavior” in both the high-yield and syndicated-loan markets. If that was the goal of Fed policy, then by all rights it has been successful.
Stein went on to say that even if his assessment were correct and junk-bond investors ended up taking a hit, “it need not follow that this risk-taking has ominous systemic implications.”
Uh-huh. And we all remember just how well the subprime crisis was contained.
Poor Mr. Stein just can’t catch a break – even when he mentions that the Fed should be more active in preventing asset bubbles as he did last week. I suppose the driving question is whether “monetary stimulus” played a role in the subprime crisis. And I have never seen any hard evidence that supports that theory; especially taking under consideration that low interest rates are a sign that money has been tight, and that the Fed influences, but does not control rates.
Ms. Baum continues:
I wouldn’t presume to know whether the narrow spread between junk-bond and Treasury yields or the rise in U.S. farmland prices is suggestive of an asset bubble. Nor am I passing judgment on the Fed’s monetary accommodation. What I am saying is that if the stated goal of the central bank is to prod the public to take risks, and the public complies with the Fed’s wishes, where does that leave us?
These are so many things wrong with the assumptions that culminate in this paragraph, but I think I’ll not start on the summation of the many fallacies it took for this question to be asked and simplify it with: Never reason from a price change. And even though she says she’s not passing judgment on the Fed’s policy (that she doesn’t even understand), I don’t really have to have a ton of cement fall on my head to get the hint here that she actually is.
I wonder why Ms. Baum would seemingly be comforted by the Fed spanking all the little children to control the price of farmland or the spread between Treasuries and junk-bonds when we have certainly been spanked enough. Oh, it must be because she doesn’t know that NGDP is ~15% below trend.
Is she suggesting a new target for the Fed? I mean it certainly cannot target inflation if the primary concern is to stop bubbles wherever they happen to be forming. It would be an interesting thing – bubble targeting – if things like “fundamentals” could be defined. Is it bigger than a breadbasket? Is that even macro?
The answer to these issues is plain enough. If you think the price of X investment is too high, take your money elsewhere. It is not up to the Fed to prevent stupid people from being separated from their money or abusing credit. It is not the job of the Fed to remove risk from investing. It is the job of the Fed, according to law, to not introduce unnecessary risk by providing a long run stable nominal environment – and if people like Ms. Baum can’t stand the heat in the kitchen as the Fed is doing so, they shouldn’t be in it.
The Fed will, sooner or later, make up a large portion of the NGDP gap. It will do so because it is the right and moral thing to do to not deny millions the basic means of survival and keep making it worse – after all, that is what employment is for most everyone.
Additionally, economic freedom is not a bad thing – it’s a very good thing that we need a lot more of. And I really wish people like Ms. Baum would seriously think through the kinds of things they are saying because the counterintuitive of the ideas of bubble bashers is that economic freedom is simply terrible, and the Fed should ignore its legal mandates and quash economic freedom wherever it might be benefiting someone other than themselves.