August 27, 2014 – So certainly we all love to discuss the fiery topics but sometimes it behooves us to spend some time on the fundamentals. I’d like to have a look at Stanley Fischer’s recent comments regarding the state of the economy that seem to buck the typical whitewash we’ve come to expect from such ‘experts’. We’ve seen a relative frenzy dissecting each word to determine exactly what to make of the prodigal economic wonder’s comments. One camp suggesting the Fed finally gets it while the other camp sees him simply laying the groundwork for more money printing. Prima facie, both seem reasonable assessments. However, if we step back and put his comments in the context of his long standing economic school of thought it becomes quite apparent that neither is correct.
What Fischer’s Fed role has been from the beginning is to lobby for more Fed control. That’s right folks the ability to print unlimited amounts of dollars from thin air just doesn’t have the zest it once did. As with any junkie, sensory adaption works to negate the intensity of the buzz one gets over time. And so junkies are on a perpetual journey to relive that initial buzz or sense of power as it were with the Fed. Perhaps a more technical way to see it is diminishing marginal returns of dollars printed. We see it in the following M2 Velocity chart.
M2 Velocity is simply GDP/(M2) Money Supply. It depicts how effective each dollar supplied is at generating economic output and well you can see from the chart we aren’t doing very well these days. How that translates in Fed language is that their power to manipulate seems to be in decline and so new powers must be delegated. Those new powers are being sought by way of a new mandate called financial stability oversight also known as macroprudential policy setting. We see Fischer discuss this new mandate in the following comments:
“It may well be that adding a financial-stability mandate to the overall mandates of all financial regulatory bodies, and perhaps other changes that would give more authority to a reformed Financial Stability Oversight Council, would contribute to increasing financial and economic stability.”
I quite like the way Dick Bove of Rafferty Capital Markets sees an expansion of Fed mandates in his following comments:
“The whole financial system and economy of the United States is now a laboratory experiment as macroprudential policies are put in place by those very people who failed to understand or correct the excesses that developed in the last financial crisis. More problematic is the fact that macroprudential policy requires regulators to control the growth and direction of the U.S. economy. It denies the right of the private sector to grow in any direction it chooses without the explicit control of the government. It is anti-capitalistic.”
Again it goes back to the fact that those in power will always attempt to beget more power because they believe they deserve it due to their higher-than-the-rest-of-us intelligence, also known as hubris.
I also want to take a stab at one quick point that keeps itching the back of my mind. Now it’s a bit technical so stick with me here. I read a paper recently by Fischer from 1977 where he takes a look at the ability of monetary policy to impact real output. He argues that activist monetary policy can affect real output in both the short and long run despite an accepted school of thought (rational expectation model) that suggests monetary policy can only affect real output in the short run. In the paper he argues two ways monetary policy can affect long run real output: firstly, by what essentially adds up to price controls, and secondly, if the actual monetary policy is known only to those setting the monetary policy i.e. the Fed (based on the accelerationist hypothesis).
Both work by way of restraining human behavior from acting rationally. So we are controlled by either legislation or by trickery to act irrationally, which the hypothesis suggests would affect real long term output. You can read the paper for the details but again the common denominator seems to be power and hubris from Fischer. I don’t think he acts maliciously but from a fallacy of a false authority. I expect in order to stop the boom and bust certainty of a Fed led economy we will need to recognize central bankers for what they are… a false authority.