Reprinted from EconLib
Many great movies are “based on a true story” – which means some parts are true, but the details and even the whole plotlines are sometimes called “poetic licenses”.
Although it’s not (yet) on the big screen, it’s Christopher Leonard The Lords of Easy Money: How the Federal Reserve Broke the American Economy Hollywood version of monetary policy. Leonard describes the activities of the Federal Reserve with a compelling narrative that reveals many difficulties in setting monetary policy, as well as dangerous consequences if those policies are wrong. To do this, however, the author has turned complex economic issues into a general story that gives many false ideas about finances and the financial system.
The protagonist in this story is Thomas Hoenig. While at the Federal Reserve Bank of Kansas City in the 1970s and 1980s, Hoenig observed that banks had expanded their risky lending based on inflationary and overly optimistic estimates. By 1991, he was president of the Regional Reserve Bank and served on the Federal Open Market Committee (FOMC), which sets the Fed’s monetary policy. Hoeing was later nominated vice chairman of the Federal Deposit Insurance Corporation (FDIC) where he championed stricter regulations for U.S. banks.
Incumbent Federal Reserve Chair Jerome Powell, who began his career as a corporate attorney and investment banker before moving into private equity with the prestigious Carlyle Group, has been cast as the villain. The Leonard Corporation focused on Powell’s work with Rexnard, who, according to Leonard, was repeatedly pressured to increase leverage and reduce costs until it was forced to lay off parts of the U.S. workforce and relocate operations to a plant in Mexico. Leonard is credited with being the primary critic of the first Quantitative Simplification (QE) program for Powell’s transition from a Fed governor to the head of the Fed chair since 2018.
The main focus Easy Money Lords The role of the Fed in credit management বা or misdirection. As an independent central bank, the Fed’s objective is, or should be, to support trade and financial system needs rather than influencing where funds are sent and invested. Leonard explains in detail how excessive expansionary policies বিশেষ especially huge financial injections under QE-can lead to additional financial markets, drive asset inflation, reach yields, and take additional risks.
The main part of the book is dedicated to the Fed driving the recurring cycle of financial risk through simple credit terms and creating risk across the entire financial system until the economy collapses into recession. Leonard blames Fed policy for a variety of economic and social ills, including increasingly fragile financial systems, increased income inequality, and even off-shoring of production যা an ongoing trend since the 1970s.
What is real vs. fiction in this story? While we must take Fed-induced risk and be wary of misallocation of credit, I suspect it was a major problem during the QE period. Yes, the Fed created an unprecedented trillion in new base money from 2008 to 2014. But the book rarely touches on the Fed’s most significant change in monetary policy: its transition from a monetary policy corridor system to a floor system when it begins to pay. Interest on additional reserves (IOER) that banks hold in the Fed.
Since the Fed was paying interest to banks to keep reserves, the lion’s share of the money generated by QE was sitting on the bank balance sheet instead of lending to the economy. Although this topic is divided among economists, in my recent research paper Journal of Macroeconomics Banks have reduced their lending as a result of the Fed’s IOER payments, possibly mitigating the effects of QE. Instead of taking risks in the financial system, banks are retaining newly-created, ultra-secure base money because the Fed is paying them to do so.
Could the new money added by QE lead to asset inflation in the larger financial system? Perhaps, but this seems unlikely. Consumer inflation has repeatedly lowered the Fed’s two percent target for nearly a decade. The Fed could have done more QE, but perhaps it could have achieved its goal by doing so Less QE If it lowers the IOER rate, which for most of the time was set higher than the short-term market interest rate. Leonard did not say how asset inflation could be detected, but the combination of below-target consumer inflation, declining debt, and higher than market rates in the IOER suggests that money যদি if anything মধ্যে was too tight during this period. , So it was probably not driving a major price bubble of financial assets.
This criticism is especially true in the case of the Great Depression of 2007-2009. As Scott puts it bluntly, the main contraction in 2008 was the result of monetary policy, not too tight, loose. Hoenig and several other FOMC members were vocal in their opposition to financial expansion. They even offered Raise Interest rates during this period. This opposition hinders the Fed’s financial expansion, which almost certainly exacerbates the recession. So while too much loose monetary policy may actually be a problem, it doesn’t seem to have been a problem in 2008 or the decade that followed. Of course, an extended Fed balance sheet can also lead to misallocation of credit, as George Selgin dubbed “Fiscal Kiwi,” not in the way described in the book.
The risk of misuse of assets and higher financial risk seems more reasonable in the recent QE period starting in 2020. High inflation has made appropriate risk analysis more difficult. The Fed has kept interest rates close to zero, despite the highest inflation in 40 years and the lowest unemployment rate since World War II. Fed officials have failed to work to reduce its monetary stimulus and have ignored warning signs of high inflation. Only time will tell whether the Fed policy has actually increased Leonard’s discussed negative effects such as excessive leverage and financial fragility.
In addition to monetary policy, the book discusses how Fed officials came under widespread political pressure during the coronavirus epidemic. The Fed has coordinated with the Treasury in its monetary policy and lending program, which, in conjunction with Coronavirus Aid, Recovery and Economic Security (CARES) legislation, allows it to go beyond its normal emergency lending role.
The Fed provided funding to nonbank companies and state and local governments, which former Fed chairmen Ben Bernanke and Janet Yellen said the Fed should never do. In contrast, Chair Powell promised that the Fed would do “whatever it takes” to support the economy. Fed officials have succumbed to political pressure to pursue climate and social goals that are clearly outside its legal mandate.
Another thing that gets the book right is Hoenig’s critique of the complexity of Unite Bank’s capital regulation. Like a complex tax code, complex regulations allow banks to understand or avoid regulations. Since regulators cannot accurately identify the risk of each asset, complexity can encourage banks to take more risk than usual. These rules encouraged banks to increase their holdings of their high-rated MBS and credit default obligations (CDOs) leading to the 2008 financial crisis.
Researchers from the Bank of England, the World Bank and the International Monetary Fund (IMF), and even the Federal Reserve Bank of New York, have found that complex rules do not better predict bank risk than general systems such as equity capital. Ratio. Complex regulations have large costs and small (possibly negative) advantages.
There are important lessons to be learned, and even readers who are already skeptical about the Fed will appreciate the thoroughness of Leonard’s explanations. Unfortunately, much of the “information” and economic explanation in the book is either inadequately explained or simply a common misconception. There are many minor errors and misrepresentations. Criticism of Leonard is often politically one-sided. He regularly calls for government intervention, but he usually fails to recognize the government as the source of such problems or private entrepreneurs can offer superior solutions.
It is possible that Leonard is right about the amount of inflation in assets. Alas, the abundant factual errors in the book make it difficult to evaluate his claims. He provides little evidence that monetary policy Created High income inequality, low economic productivity, or changes in production technology — all of which seem to be largely due to non-financial factors.
Easy Money Lords The dangers of flawed monetary policy play an attractive role, but readers should be skeptical of the Hollywood version. Should we criticize Fed policy? Yes. Should we worry about misuse of resources and excessive financial risk? Absolutely. Should we blame every economic problem (real and imaginary) on the Fed? As Tom Hoenig would say, “Respectfully, no.”