The Fed Debate

Sep 5, 2012 • 329 Views
EST. TIME TO READ: 3 minutes

10 years ago, the future Federal Reserve Chairman Ben Bernanke said to Nobel laureate Milton Friedman, “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

What won’t they do again? As David Wessel explains in his book, In Fed We Trust, Dr. Bernanke believed that the devastating synergy between tight monetary policy and failing banks made the 1930s economy implode. And, as the head of the Fed when the economy was nosediving, he was not going to let it happen again.

As the guardian of monetary policy, the Federal Reserve oversees the supply of money and credit. Sort of like Goldilocks and the 3 bears, monetary policy makers have to be sure that the money supply is not too much nor too little but just right. Their goal is a balance between the goods and services the economy produces and the money we have to buy them. Too much money is inflationary because too many dollars are chasing what we can buy; too little money means we cannot buy all that has been produced. The problem, though, is that people disagree about how to achieve “just right” monetary policy.

And that takes us to the current debate.

We have had QE1 (quantitative easing) which most economists believe was necessary. As the economy was contracting in 2008, the Fed poured money into banks, other financial institutions and corporations by purchasing different kinds of securities. When they buy securities, the Fed gets the paper while the seller gets the money. A lot of that money finds it way to banks, thereby helping their solvency and (theoretically) their ability to lend.

After QE1, we got QE2. Now QE3 is being debated and not everyone at the Fed agrees.

  • One group says the economy needs another boost from the Fed. Believing that Fed policy should be based on current economic conditions, they say high unemployment and other weak economic indicators require another monetary stimulus. In a Bloomberg interview, San Francisco Fed president John Williams said that lower interest rates create jobs. Referring to the US economy, he said, ” I think what we want to do now is think about a sick patient. You want to get him or her as strong as possible, as well as possible so if they get hit by another shock or another problem they’re in a good position to fend that off.”
  • By contrast, a new paper published by the Dallas Fed, “Ultra Easy Monetary Policy and the Law of Unintended Consequences” says the Fed  should not respond to current data. Emphasizing that easy money policy is not a “free lunch,” the paper explains why the health of financial institutions, the functioning of financial markets, the “independence” of central banks, and prudent government behavior will be sacrificed.


In his August 31st talk on at Jackson Hole, Wyoming, Ben Bernanke’s position echoes his promise to Milton Friedman.

For an excellent, brief explanation of quantitative easing that my class enjoyed and easily grasped, do look at this “whiteboard.” Much longer but clear and interesting, David Wessel’s In Fed We Trust is quite good for insight and facts about the Fed and Dr. Bernanke. Finally, for my facts about the current debate, here is the Dallas Fed paper against easy monetary policy, here is an unofficial transcript of a Bloomberg interview of John Williams, the San Francisco Fed president, and here is more about the Bernanke Jackson Hole speech.

More from Econlife on quantitative easing is here and here.

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