Defining Ideas

Wrong For The Fed

Tuesday, April 16, 2019
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President Trump has nominated free-market economist Stephen Moore to be a member of the Federal Reserve Board of Governors. In that position, Moore would be in a pretty exclusive club: one of 12 people (seven board members, including Chairman Powell, plus five presidents of regional Federal Reserve banks) who get to vote on monetary policy.

The nomination has stirred a lot of controversy. Writing in the New York Times last week, Harvard economics professor N. Gregory Mankiw, who was chairman of the Council of Economic Advisers under President George W. Bush, accused Moore of being “a propagandist, pushing for conservative causes, often with flimsy arguments.” Democratic Senators are expected to vote against Moore’s nomination and even a few Republican Senators have expressed skepticism.

You might think that I, who often agree with Stephen Moore on economic policy, would favor his nomination. I don’t. Before you jump to conclusions, this has nothing to do with personal animus towards him. He and I spoke at the same event at Southern Methodist University in 2010 and got along quite well. I rather like the guy. Instead, it’s simply that I think he’s unqualified. But we shouldn't overstate the case against him. The case against having Moore on the Fed does not depend on the idea, as Mankiw seems to believe, that the Fed is a great organization. It’s not. And there’s a strong case against having a central bank in the first place.

First, let’s consider why Moore shouldn’t be on the Fed. Some people have argued that the fact that he lacks a Ph.D. in economics disqualifies him. I don’t think so. Moore has a Masters in economics and a number of well-known economists have taken fewer formal economics classes than Moore. The late Gordon Tullock, who was on many people’s short list for the Nobel Prize in economics, took one course at the University of Chicago, before going to be one of the founders of the Public Choice school of economics. David Friedman, who most recently was an economics professor at Santa Clara University’s law school, never took an economics course in his life—although admittedly, he learned much of his economics from his father, Milton. Alan Reynolds, a very productive economist for over 40 years, never completed his Masters at Cal State Sacramento.

The argument against Moore is simpler: even by his own admission, he doesn’t have much background in monetary theory or monetary policy.

The most important thing the Federal Reserve does is determine monetary policy. It has many tools. Of its two most powerful tools, one is long-standing and the other relatively new. The first is open market operations, which means buying and selling bonds to affect the amount of money in the economy. If the Fed wants to increase the money supply, it buys bonds; to reduce the money supply, it sells bonds. The relatively recent tool, introduced during the financial crisis, is paying interest on the required and excess reserves held by depository institutions. The higher the interest rate the Fed pays banks on their reserves, the less willing they are to lend, which causes the money circulating in the economy to be less than otherwise.

So one would want to know where Moore stands on these issues.

Fortunately, Moore has given us a hint about his views of monetary policy overall—and it’s not comforting. Scott Sumner, a monetary economist with the Mercatus Center and my co-blogger at EconLog, put it well:

Both candidates [Stephen Moore and Herman Cain, the other Trump nominee] have argued that monetary policy was too expansionary during the early 2010s, and both recently suggested or at least implied that a more expansionary policy would now be appropriate. While each view is defensible when considered in isolation, there is a great deal of evidence that policy was too contractionary during the early 2010s, as the Fed fell short of both its inflation and employment objectives. If Fed officials could do it all over again, they would almost certainly adopt a more expansionary policy during the early 2010s. So it looks like Moore and Cain were wrong in their earlier hawkish views.

I focus here on Moore both because it seems clear that Cain will not be confirmed and because the case for non-economist Cain is even weaker than the case for Moore.

There are two possible ways to reconcile Moore’s hawkish views in the early 2010s and his dovish views today. Neither should give us confidence. The first way is that he simply doesn’t understand much about monetary policy. The second is that his views on monetary policy depend on who is president. When someone he opposed (Obama) was president, Moore said that a monetary policy that was too tight—look at the huge recession—was too loose. But when someone he supports (Trump) is president, Moore thinks that a loose monetary policy is the right way to go.

There are jobs in the Trump administration where Stephen Moore would be a net plus. One would be as, say, assistant secretary of the Treasury for economic policy. The slot is currently vacant. I can think of one other job where Moore would be good, but it’s a job that Trump would never ask him to fill. It would be to replace protectionist Robert Lighthizer as U.S. Trade Representative: Moore is a free trader.

If President Trump wanted a first-rate economist who also has an independent view, then a plausible choice would be Scott Sumner. Sumner, with his other blog, The Money Illusion, has almost single-handedly brought discussion of nominal GDP targeting into the policy arena.

In making his case against Moore for the Fed, Greg Mankiw waxed eloquent about the Fed. His New York Times op-ed is titled “Keep the Federal Reserve I Love Alive.” Sometimes editors go overboard, choosing titles that go far beyond the message of the author. But here is Mankiw’s first paragraph:

I have a confession to make: I love the Federal Reserve. And I suspect that, in their heart of hearts, most other economists love the Federal Reserve, too. But I fear our love may be in peril.

“Love” is a strong word. This is a mash note.

How does Mankiw justify his love? He argues that the 20,000 employees of the Fed “do their jobs well.” He admits that the Fed screwed up during the financial crisis and the Great Recession, although the main mistake he admits is not rescuing Lehman Brothers. He goes on to argue that people shouldn’t be judged “by the standard of perfection.” True. But he’s not arguing just for having good, competent people at the Fed; he’s arguing for having a Fed.

If we must have a Federal Reserve, I also want good people to staff it. But the bigger question is whether we need a central bank. Mankiw seems to take the answer as given, but it’s an open question. In a speech I gave at the San Francisco Fed’s annual conference of Twelfth District Directors in 2014, I asked the audience, “Is planning the money supply easier than planning the steel industry or the auto industry?” (Incidentally, possibly because of that question, my answer that it’s not, and fellow presenter Atif Mian’s telling the audience he agreed with me that the Fed probably can’t spot bubbles in advance, the San Francisco Fed broke with precedent and “regrettably” decided not to post the videos.)

One argument for having a central bank is that it will help us avoid the instability that we had before the Fed existed. But a large volume of scholarly work has concluded that the instability, to the extent it existed, occurred because of government regulation of banks.

In many states, for example, each bank could legally have only one branch. That meant that when one bank’s portfolio collapsed, it couldn’t make good on deposits from another branch because there weren’t other branches. George Mason University economist Lawrence H. White points out that in Scotland and Canada, where free banking without a central bank was tried, “it functioned well for the typical user of money and banking services.” Free banking, he notes, often ended “because the imposition of heavy legal restrictions, or creation of a privileged central bank, offered revenue advantages to politically influential interests.”

Moreover, in a path-breaking 1986 article in the American Economic Review titled “Is the Stabilization of the Postwar Economy a Figment of the Data?” Christina D. Romer, an economics professor at UC Berkeley and the first chairman of President Obama’s Council of Economic Advisers, answered, essentially, yes. In summarizing her study for the first edition of The Concise Encyclopedia of Economics, Professor Romer wrote:

In some recent research, I have tried to avoid the problem of inconsistent data by comparing the crude prewar statistics with equally crude postwar statistics. That is, I have compared the existing prewar series with modern data that are constructed using the same assumptions and data fragments that were used to piece together the prewar series. These comparisons show essentially no decline in the severity of cycles between the prewar and postwar eras. They also show little change in the duration and frequency of cycles over time. Thus, much of our apparent success at eliminating the business cycle seems to be a figment of the data.

The prewar era she refers to is pre-1914, which means that it was before the Federal Reserve existed. (The Fed began on December 23, 1913.) The postwar era is the era after 1947. Professor Romer purposely left out the Great Depression. Many economists do such comparisons, presumably because they regard the Great Depression as the Fed’s steep “learning curve.” Even doing that, she found no increase in stability due to the Fed. And of course we know that on inflation, the Fed has done a much worse job than the pre-Fed gold standard. During the period of the classical gold standard, 1880 to 1914, inflation averaged 0.1 percent annually. Between 1947 and 2018, annual inflation has average 3.5 percent. Since the Fed began, the value of the dollar has fallen by 96 percent.

Professor Romer wrote her 1986 study before both the “Great Moderation,” the period of stability between the mid-1980s and 2006, and the Great Recession, which went from December 2007 to June 2009.  So on the one hand, the Great Moderation would make the postwar period look much better overall. But on the other, the Great Recession offset much of that better postwar performance. So her 1986 postwar conclusion, that the postwar stability is not much different from the prewar performance, is probably still not far off the mark.

I mentioned earlier that the Fed started paying interest on reserves during the financial crisis. Whatever the wisdom of using that tool, it was introduced at the exact wrong time. The Fed should have been expanding the money supply and, had it done so, would have made the last recession much less extreme. But by starting to pay interest on reserves, it caused commercial banks to lend less than otherwise, making the money supply less than otherwise. That was one of the main factors in the Fed’s too-tight monetary policy.

What if, like me, you think President Trump should appoint a well-informed monetary economist who doesn’t automatically accept that the Fed should exist? In that case there’s a good case for appointing Lawrence H. White. President Trump and Stephen Moore often talk about the importance of “draining the swamp.” In a 2005 article, White wrote, “[S]ome 74 percent of the articles on monetary policy published by US-based economists in US-edited journals appear in Fed-published journals or are co-authored by Fed staff economists.” Now there’s a swamp! And I don’t think Moore will help to drain it.