Has the Fed lost its way?
The Federal Reserve System celebrates its 100th birthday this year. Rather than hold a self-congratulatory party, the Philadelphia Fed convened a policy forum that looked at current policy in an historical context, asking what the Fed is doing wrong and whether it is straying from established principles of sound central banking.
While there was some criticism of the Fed’s role in the Financial Crisis and evocations of Walter Bagehot, the focus was more on what the Fed is doing now—particularly on Quantitative Easing and asset purchases. While QE1 succeeded in shoring up the economy, it’s unclear whether QE2 and QE3 have accomplished much beyond expanding the Fed’s balance sheet. Inflation seems tame, but a review of the ‘60s and ‘70s is cautionary: in 1970 inflation appeared low and the Fed became highly stimulative—just on the eve double-digit price rises.
Going forward, the Fed is likely to reduce its asset purchases and rely more on forward-looking communications. But transparency is not a panacea: economic conditions are bound to be more complex than we think, and too-frequent communication and revision can confuse rather than clarify.
As long as we use money, monetary policy will be controversial. Serious self-criticism is a hopeful sign that we won’t simply repeat the mistakes of the past.
Douglas R. Tengdin, CFA
Chief Investment Officer