CQ WEEKLY
March 31, 2012 – 2:02 p.m.
Political Economy: Too Many Economists
By John Cranford, CQ Columnist
Jokes about economists holding contradictory opinions based on the same set of observable facts are a dime a dozen. Or less, if you use present-value accounting. The playwright George Bernard Shaw (who helped found the London School of Economics) is credited with the old saw that if the world’s economists were laid end to end, they still wouldn’t reach a conclusion.
Last week, at a largely dry-as-dust hearing intended to build a case for changing the underlying charter of the Federal Reserve, this phenomenon was clearly manifest. Three respected, experienced practitioners of monetary policy were asked to evaluate a bill by Texas Republican Rep.
To no one’s surprise (at least no one who was paying close attention and who knew the subject and the personalities), the three gave reasoned, compelling — and contradictory — responses.
This would be funny if it weren’t so serious.
What Brady wants to do seems simple on its face and consistent with central bank practices elsewhere in the world. That would be to charge the Fed with one and only one responsibility: preserving the value of America’s currency.
The title of Brady’s bill says it all: the Sound Dollar Act.
To make this happen, Brady would eliminate the “dual mandate” under which the Fed has operated for more than a third of a century. That mandate — to pursue the seemingly opposite goals of price stability and maximum sustainable employment — is different from the charge issued to most other central bankers.
Around the world, fighting inflation is the singular responsibility of most of the Fed’s counterparts. Some, like the European Central Bank, approach the task with religious fervor. The inflation-averse ECB, following the behavior of its hawkist progenitor, the German Bundesbank, would be expected to raise interest rates to choke off the mere whiff of inflation even in the midst of a recession.
That’s not necessarily true of the Fed (but more on that later). And that’s what has Brady and his 31 cosponsors deeply concerned.
To Brady, work done decades ago by John B. Taylor, one of the witnesses before the Joint Economic Committee last week, represents the paragon of central banking. Taylor, an economics professor at Stanford University and former undersecretary of the Treasury for international affairs, has long promoted the idea that a mathematical equation can and should be used to set monetary policy.
Under that equation, known in economic circles as the Taylor Rule, an ideal interest rate would be derived from a formula using inflation and the degree to which economic growth does not match its potential. That interest rate would be intended to foster a desired degree of economic activity and keep inflation close to a goal.
Under Taylor’s prescription, deviation from the rule would have to be explained to Congress.
Changing Times
Political Economy: Too Many Economists
What Taylor and his allies really want, of course, is to tie the hands of the central bank, to limit its flexibility. In particular, they believe that the Fed under Chairman
Since the beginning of the Great Recession, Bernanke has defended his actions with regular references to the dual mandate. He insists that it doesn’t imply a contradictory policy response but rather that inflation and employment are complementary policy guides. Bernanke also believes in using an inflation target. And in January, the Fed said what many observers have long thought, that it operates with the aim of allowing an inflation rate of 2 percent.
Paul A. Volcker is proof that a flexible approach to monetary policy making under the dual mandate worked in one circumstance: when inflation was out of control in the late 1970s. As Fed chairman, Volcker professed that the only way to achieve maximum employment was to break the back of double-digit inflation.
The question is, why won’t some give Bernanke the benefit of the doubt today, when circumstances arguably are as dangerous as those Volcker faced — if not more so. It’s just different.
The short answer may just be that, for some people, inflation is the be-all and end-all of monetary policy, and Bernanke went too far.
Another of the witnesses at Brady’s hearing was Laurence Meyer, a former Fed governor and a serious inflation hawk. Meyer, though, offered a vigorous defense of the dual mandate and of Bernanke’s actions — and he pointedly denounced efforts to tie the Fed to a strict inflation-fighting regime. In objecting to Brady’s bill, Meyer quoted Bank of England Governor Mervyn King, who refers to advocates of inflexible rules as “inflation nutters.”
Meyer hasn’t always held quite that opinion. In the late 1990s, when the economy was humming and inflation was in check, he would have nothing to do with discussions about the Fed’s role in watching employment. But times have changed and, even if Taylor’s views haven’t changed a bit, Meyer’s have.