Myth-busting The Federal Reserve

December 26, 2012

There is a subset of macro-economics (governmental economics as opposed to micro-economics which pertains to business and individuals) that is by far the most misunderstood, mis-reported, and blamed unfairly(mostly by the GOP)—The Federal Reserve System; it’s time to do some myth-busting.

By giving in to participating on social networking sites like Twitter, LiveNewsChat, Facebook, etc., I get a LOT of questions (and arguments) about economics. “The Fed” is by far the most misunderstood aspect of governmental economic principles (macro-economics) especially among conservative supporters and pundits (gawd I hate that expression).

Myths about the Fed are legion (repeated ad nauseam by pundits and politicians) and it seems that chairman Bernanke realizes that the more exotic Fed policy becomes, the more he must inevitably debunk memes in order to justify his actions. Lowering rates during normal times is fairly uncontroversial and easy to understand, except when a Democrat inhabits the White House. The last Republican to reduce the defict by even a single dollar, was Calvin Coolidge, yet the deficit increases under Reagan, Bush Sr. and Bush Jr. never seemed to matter.

Even though activities of the Fed are likely to result in a lower national debt over the long term, I often hear the complaint that the Federal Reserve is enabling bad fiscal policy by keeping interest rates very low and thereby making it cheaper for the federal government to borrow.

However, the responsibility for fiscal policy lies squarely with the Administration and the Congress. There Federal Reserve is not even a governmental entity. It receives it’s authority and funding from the nation’s private banking system, it’s Board of Governors and does not answer to Congress nor the Administration. At the Federal Reserve, they are tasked with implementing monetary policy to promote maximum employment and price stability, as the law under which they operate requires. Using monetary policy to try to influence the political debate on the budget would be highly inappropriate and apparently it is only the GOP that feels comfortable using unintended, obscure parliamentary procedures to further their political agenda (i.e, debt ceiling increases).

I also hear quite often that the Fed is destroying the dollar by continuing to “print more money”, but to discuss “the dollar” is to really discuss two different concepts that are easily confused.

One is the exchange rate of the dollar against various currencies. It goes up, down, etc. It is but one tiny fraction of the calculation that the Fed makes in determining U.S. monetary policy.
What the Fed watches — and which matters for consumers — is inflation (the ongoing measure of its purchasing power of items that people buy).
It’s clear that inflation has been modest by historical standards, and that the Fed has been a good steward of the dollar.

Myth-busting the GOP federal Reserve Claims

Most arguments about the Fed begin with the fear of inflation and the claim that low interest rates don’t prove anything. The usual (lack of) reasoning goes that the only reason interest rates have remained so low is because the Fed has been buying up all the government’s debt issue. As soon as I hear this gem, I know that the person repeating this drivel has relied upon too many hours of YouTube or FOX “News” for their knowledge foundation, despite their usual insistence that they are economics majors or some such. Actually, the idea is extraordinarily irrational and manages the elusive hat trick of misinformation.

First of all, it’s patently false that the Fed has consistently been buying a lot of U.S. debt issue. It has bought some for sure, but only as dictated by demand. Each time a QE has stopped, there were far-flung forecasts that interest rates would spike. Of course, they did not, despite the predictions of such luminaries as PIMCO’s Bill Gross and the GOP’s liar-in-chief and supposed economic wunderkind, Paul Ryan .

The idea is also theoretically wrong. Asset prices are normally determined by availability, desirability, and/or demand for those assets, not the changes in these characteristics over short time frames. If bond investors lose confidence in U.S. debt, there would be a huge amount of U.S. debt paper for them to try to sell, driving rates up, no matter how much of the new issue the Fed might be buying.

Lastly, when did people who constantly worry about the size of the U.S. deficit (GOP?) begin believing that the Fed can monetize a significant part of a large deficit, for four years, without any negative consequences? That assertion has not happened and directly disproves their claim.

The so-called supply-side fanatics have repeatedly proclaimed that the “printing of all that money” should have expanded the monetary base exponentially and produced runaway inflation by now.

It hasn’t.

And the conspiracy theorists continue to repeat the mantra and emergency exit of all baseless arguments…”just wait, it’s coming”.

Another favorite is that the evil government is hiding the true rate of inflation (you mean the way George W. Bush did?). Wrong again. Independent estimates are not significantly different from the official gauges.

The persistence of the deficit-hawk meme, however, despite year after year of failure, is a testament to the voting public’s lack of understanding regarding the differences between business and governmental economics and the depth propagandists on FOX and AM Radio have achieved.

But it’s also a sad statement of on the politicization of exploiting economic fears for political purposes, despite the damage it causes.

HgTransEcon

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