Monday, December 06, 2010

The Trouble with Mixing Economics and Politics

Last night 60 Minutes ran an interview with Federal Reserve Chairman Ben Bernanke, who seems to have requested the interview to straighten up some of the misunderstandings concerning the Federal Reserve's QE2 program.

The QE2, (Quantitative Easing 2) program is a plan for the Fed to buy $600 Billion in treasuries in order to push down long term rates which help lower the cost of mortgages which would help with the housing crisis.

Of course, the general problem is that people think that the Fed is printing $600 Billion in order to push long term rates down. This is false. The Fed is just buying 10 and 30 year t-bills in order to push long term rates down. The money supply is staying the same. People further believe that this will cause hyper inflation. This too is false since we are close to deflation and the Fed has so many tools available to slow inflation if it should show up.

The underlying issue is a push by some politicians to rein in the Fed and bring it under the control of Congress. However, like all modern economies, an independent central bank is absolutely necessary. Otherwise, we would have the same silliness going on in our monetary policy as is in our fiscal policy.

Back in 2008, during the meltdown of the world economy, you saw the real limits of the political understanding of macroeconomics. They didn't understand the banking crisis, nor the Fed's response to it. They didn't truly understand TARP. They still don't understand most of the tax policy that they actually wrote.

Nothing could be more dangerous than to have the power of the Fed subject to the ebbs and flows of political  favor. The Fed is charged with keeping inflation in check and maintaining full employment. Most people in know, accept that there are few tools available to the Fed to keep us at full employment. They cannot affect demand or supply. All they can do is affect the money supply and to some extent the interest rates which impacts economic activity through the cost of financing growth and investment.

The actual growth and investment must start with a market in need of a product or service. Interest rates could be negative, but without demand for goods and services, there will be no growth. (example: Japan).

Economics can be hard to understand. Yet, it is understandable with a little effort. Those who drive public opinion would do well to understand the subject before pushing an agenda. Leave politics out of monetary policy.

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