David Frum

04.13.12

This is Why the Federal Reserve Can't Save the Economy

the-fed-2006-cs
This 26 March, 2006 photo shows the US Federal Reserve in Washington, DC. (Karen Bleier / Getty Images)

Via Mark Thoma, I learn that Minneapolis Federal Reserve Bank President Narayana Kocherlakota doesn't think that the Fed should stick to its current policy of keeping interest rates low till 2014:

I would say that it would be appropriate to change the Fed’s current forward guidance to the public about the future course of interest rates. Currently, the FOMC statement reads that the Committee believes that conditions will warrant extraordinarily low interest rates through late 2014. My own belief is that we will need to initiate our somewhat lengthy exit strategy sometime in the next six to nine months or so, and that conditions will warrant raising rates sometime in 2013 or, possibly, late 2012.

Kocherlakota is not one of my favorite Federal Reserve board members. My own opinion is that tighter money now would be a terrible idea and would harm the economic recovery.

But lets think about what sort of bind this puts Fed Chairman Ben Bernanke in. One of the most important aspects of Federal Reserve policy is its ability to be credible. When the Fed says it will do something, the policy is more likely to work if markets believe the Fed will follow through. Currently, the Fed has committed to keeping interest rates near 0% till late 2014.

So when the one of the bank Presidents (who is not currently a voting member but will be again in 2014) expresses concern that this policy should be reversed, then there is a new level of doubt: how credibly can we take Federal Reserve statements when they come attached with a date?

Bernanke is in the unenviable position of trying to run an organization where ideally, he wants consensus. This consensus is unfortunately hard to achieve so even statements that simply continue current policies still get dissenting votes and public criticisms of the policy.

When even maintaining the current policy is tenuous, what hope is there that the Fed will be able to take stronger measures to support the economic recovery?