Grading the Fed

George Washington's picture

Washington’s Blog.

How well has the Federal Reserve performed for America?

There are many allegations (more in a future post) that the Fed has manipulated the markets.

There are also claims
(more to come) that the Federal Reserve System saddles the U.S. government and
American people with trillions of dollars in unnecessary debt (that
would not be incurred if the government took back the "power to coin
money" granted to the government itself in the Constitution).

But let's ignore all that for a minute, and look at conventional metrics for measuring the performance of the Fed.

pundits, of course, say that Bernanke has saved the world . . . . but
they said the same thing about Greenspan. So let's look at the actual historical record to determine how well the Fed has done.

Initially, Milton Friedman and Ben Bernanke have both said that the Federal Reserve caused (or at least failed to cure) the Great Depression through its poor monetary policy.

also blame the Fed for blowing an unsustainable bubble between
2001-2007 through artificially low interest rates. If this sounds too
much like an Austrian economics perspective, that may be true. But
remember that Hayek won the Nobel prize in 1974 partly for arguing that
artificially low interest rates lead to the misallocation of capital and to bubbles, which in turn lead to busts.

one of the Fed's main justification has been that it can provide a
"counter-cyclical" balance. In other words, during boom times it can
put on the brakes ("take the punch bowl away right as the party gets
started"), and during busts it can get things moving again. But as
economist Jane D'Arista has shown, the Fed has failed miserably at that task:

D'Arista, a reform-minded economist and retired professor with a deep
conceptual understanding of money and credit [has a] devastating
critique of the central bank. The
Federal Reserve, she explains, has failed in its most essential
function: to serve as the balance wheel that keeps economic cycles from
going too far. It is supposed to be a moderating force in American
capitalism on the upside and on the downside, the role popularly
described as "leaning against the wind." By applying its leverage on
the available supply of credit, the Fed can slow down a boom that is
dangerously overwrought or, likewise, stimulate the economy if it is
sinking into recession.
The Fed's job, a former chairman once
joked, is "to take away the punch bowl just when the party gets going."
Economists know this function as "counter-cyclical policy."


The Fed not only lost control, D'Arista asserts, but its policy actions
have unintentionally become "pro-cyclical"--encouraging financial
excesses instead of countering the extremes.
"The pattern that
has developed over the last two decades," she wrote in 2008, "suggests
that relying on changes in interest rates as the primary tool of
monetary policy can set off pro-cyclical foreign capital flows that
tend to reverse the intended result of the action taken. As a result,
monetary policy can no longer reliably perform its counter-cyclical
function--its raison d'être--and its attempts to do so may exacerbate

The Fed is also supposed to act as a regulator for banks and their affiliates, but failed miserably in that role as well.

Indeed, the central bankers' central banker - BIS - has itself slammed the Fed:

a pointed attack on the US Federal Reserve, [BIS and its chief
economist William White] said central banks would not find it easy to
"clean up" once property bubbles have burst...


Nor does it
exonerate the watchdogs. "How could such a huge shadow banking system
emerge without provoking clear statements of official concern?"


fundamental cause of today's emerging problems was excessive and
imprudent credit growth over a long period. Policy interest rates in
the advanced industrial countries have been unusually low," [White]


The Fed and fellow central banks instinctively
cut rates lower with each cycle to avoid facing the pain. The effect
has been to put off the day of reckoning...


"Should governments
feel it necessary to take direct actions to alleviate debt burdens, it
is crucial that they understand one thing beforehand. If asset prices
are unrealistically high, they must fall. If savings rates are
unrealistically low, they must rise. If debts cannot be serviced, they
must be written off.


"To deny this through the use of gimmicks and palliatives will only make things worse in the end," he said.

The head of the World Bank also says:

banks [including the Fed] failed to address risks building in the new
economy. They seemingly mastered product price inflation in the 1980s,
but most decided that asset price bubbles were difficult to identify and to restrain with monetary policy. They argued that damage to the 'real economy' of jobs, production, savings, and consumption could be contained once bubbles burst, through aggressive easing of interest rates. They turned out to be wrong.

As PhD economist Steve Keen has pointed out, the Fed (along with Treasury) has also given money to the wrong people to kick-start the economy.

Remember also that Greenspan acted as one of the main supporters of derivatives (including credit default swaps) between the late 1990's and the present (and see this).

Greenspan was also one of the main cheerleaders for subprime loans (and see this).

The above list is only partial.


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Gordon_Gekko's picture

Here's my grade: FAIL.

Lionhead's picture

GW, you're smokin' hot today!!  ;)  Right on, Mr Founding Father....  My grade for the FED, F---  They've washed out of the class and are headed for the unemployment line. Moreover, they should be all prosecuted and sent to Gitmo with the other terrorists.

Anonymous's picture

Of course they failed and will continue to do so. Common sense dicates that. Let's see:

Population of over 307 million whose most basic economic factors are decided by a group that is probably under 1,000 and operates in a bubble of privilege.

Seems silly to think that they could do any less than fail the majority. They are too busy taking care of their buddies in the bubble.

Besides they are not Gods. They are pointy heads and think parochially like pointy heads are wont to do. They are trying to replace millions of individual decisions with guess work based on their constricted and privileged sense of our economic realities.

They need to be terminated and replaced with free market mechanisms and now is the time to do it.

Hephasteus's picture

Fail. Cornerstone is illusory lie. Structure crumbles.