Trying to teach my three year old to play Angry Birds was initially rather frustrating. She was more enamored with the slingshot rather than actually trying to knock anything down. Not surprising since she is three years old, after all. But, this meant she typically pulled back the sling shot in random directions, often repeatedly driving the bird directly into the ground. While frustrating to watch, it seemed to please her and she eventually became more focused on knocking down structures. Now it is frustrating that my still three old daughter is better at Angry Birds than me.
I was reminded of my daughter while reading about Mr. Bernanke's recent comments on monetary policy. Monetary policy is somewhat like a sling shot. The Fed stimulates the economy by pulling back and releasing on the rubber band by cutting interest rates and letting the economy fly forward. While the economy arcs through the air the Fed can re-load the energy in the slingshot by raising interest rates for when the economy next slows. I recognize this is not a perfect analogy because the Fed is not trying to hit a specific target in the distance but instead trying to reach a certain height, or inflation/ unemployment level, while maximizing the distance of the arc, or period of time.
The reason for offering the Angry Birds analogy is that I believe the Fed's slingshot is stretched out and the bird/ economy is getting heavier. By repeatedly trying to snap the economy higher the Fed has stretched out its slingshot, in my view. Furthermore, by allowing on-going inefficient capital allocations in the economy through repeated stimulation at the initial signs of slower economic growth, the dead-weight in the economy has increased. I believe these combined issues have deteriorated the Fed's slingshot to where it must "aim higher" in order to reach the desired economic lift, at the expense of the distance in the arc. My fear is that soon the Fed may need to pull straight down in an attempt to push the economy to the desired height, resulting in a brief and ultimately unsuccessful boost. In other words, the much desired "escape velocity" for the economy is becoming more and more remote.
But my concerns expanded recently after recent speeches by Mr. Ben Bernanke. On March 22 Federal Chairman Mr. Ben Bernanke gave a speech at George Washington University in which he claimed "monetary policy did not play an important role in raising house prices during the upswing."
This comment is somewhat confusing and increases my feeling of unease. My initial interpretation is that Mr. Bernanke is becoming more concerned with how people perceive him than actually ignoring the political pressures, learning from history, and applying a critical analysis to improving actions in the future.
The fundamental role of the Federal Reserve, as I see it, is to impact the expansion or contraction of credit in the economy to provide price stability and full employment. For the Chairman to claim monetary policies do not have an impact on credit availability in certain segments of the economy, and thus economic expansion, implies either he believes monetary policy is irrelevant or extremely specific in its application. Both implications strain credibility, in my mind.
That said, I believe Mr. Bernanke was offering a Goldilocks explanation, in which monetary policy was just right to stimulate demand but structural problems resulted in housing over-heating. While convenient for his legacy, I believe this explanation actively ignores the Fed's role in the economy. By side-stepping deeper recessions over the past few decades the Federal Reserve has encouraged inefficient or out-dated economic structures to remain in the economy. Furthermore, if Mr. Bernanke believes the problem is structural, then to continue pursuing aggressive monetary policies when one knows there are problems is like a builder adding another level to a house when they know the foundation is weak. The risk increases of it all coming crashing down.
I raise this comment to make the following points:
(1) The Federal Reserve policies remain a hammer looking for a nail.
(2) Significant structural inefficiencies have likely continued to build up in the economy.
(3) The root cause of Sagflation likely remains in place, which is overly aggressive monetary policies enabling the inefficient allocation of capital. This likely produces heightened price volatility with stronger swings between inflation and deflation.
To return to my Angry Bird analogy, my expanded fear is that the Federal Reserve is becoming less concerned about its "aim," and more enamored with how to stretch the slingshot further in order to try and recover the power of its snap. Much like my daughter who found she could pull the slingshot back further if she pulled it straight-up, I now fear that the Federal Reserve may begin to start aiming at the ground in order to stretch the band further. Whether this leads to deflation or excessive inflation is yet to be determined, but real economic growth likely suffers.
One last point I'd like to make clear. In my view, Congress clearly is a major part of the problem due to its difficulty in passing legislation, the influence of special interest money, and inflexible bipartisan positions. In many ways, Congress represents the crumbling foundation. That said, the Federal Reserve is enabling the problems to fester and deepen, possibly creating a larger issue in the future, in my view.
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