Move My Office

If this keeps up, Federal Reserve Chairman Ben Bernanke should move his office to the White House. The cacophony about QE2 continues to undermine the Fed's independence and role in monetary policy, as it appears that there is now a philosophical divergence between the Federal Reserve Chairman and a number of Governors, who appear to be talking more like traditional central bankers.

Let's think about traditional, non-monetary sources of inflation, apart from commodity price shocks and one-time events. Pressures from non-monetary sources should be reflected in capacity utilization rates in key industries, or in labor market measures, such as hours worked, overtime, unfilled job orders, and hourly labor rates. On all of these measures, there is no evidence of imminent inflationary pressure to be found. In the Chairman's own words, "We see an economy which has a very high level of under utilization of resources and a relatively slow growth rate."

What's fundamentally wrong with the continuing reliance on monetary instruments like QE2? Fed Governor Kevin Warsh, quoted in today's Wall Street Journal, says, "The Federal Reserve is not a repair shop to fix broken fiscal, trade or regulatory policies." It is, however, acting as if it were such a repair shop, providing band aids for the continuing lack of any coherent fiscal policy initiatives to improve capacity utilization, investment, or the labor markets.

Chairman Bernanke has made comments about the effects of negative real interest rates helping consumers repair their balance sheets by driving equity prices higher. I thought we should have learned from former Chairman Greenspan's tenure that this isn't the brief of a central banker. The late Nobel Laureate economist Milton Friedman would be jumping up to object to this line of argument as well. For the broad swath of U.S. consumers, higher equity prices are primarily reflected in the market values of their 401(k)'s. Unless they were to take out loans against these, they should have no impact on consumption. In Friedman's theory, they would look through this paper effect and conclude that there was no true increase in their permanent income, and hence they would not raise their consumption levels. This entire line of reasoning is misguided and off-target.

Where the Fed's QE initiatives appear to be succeeding is in driving down the value of the U.S. dollar, and creating a new carry trade where the funds are flowing to emerging markets and commodities. Unfortunately, these policies stimulate reactions by our trading partners in a negative feedback loop. So, Wall Street wins and Main Street continues to have the street lights out. Let's see if an emboldened Republic leadership and a chastened Democratic leadership can cobble together some meaningful budget reductions and fiscal stimulus that encourages investment. That would be nice.