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Saturday, January 07, 2006

"Boys dying in Vietnam, and Bill Martin doesn’t care!"

Dallas Fed president Richard Fisher tells economists gathered at the ASSA meetings in Boston that their econometric models aren't much help. He also stresses the importance of Fed independence by recounting a story from the 1960s about president Johnson and William Martin, Fed president at the time:

Coping with Globalization's Impact on Monetary Policy, by Richard W. Fisher, Dallas Fed President,January 6, 2006: Many of my fellow Federal Reserve Bank presidents are economists ... I am not. ... I do not mind admitting to some apprehension about speaking to an audience of economists on an economic topic. But I am very comfortable with ... one of the biggest challenges my colleagues and I must cope with: globalization’s impact on ... the economy and the making of monetary policy.

The literature on globalization is large. The literature on monetary policy is vast. But the literature examining the combination of the two is surprisingly small. ... The word “globalization” does not appear in the index of Michael Woodford’s influential Interest and Prices: Foundations of a Theory of Monetary Policy. Nor do the words “international trade” or “international finance.” What gives? Is the process of globalization disconnected from monetary policy? Is central banking totally divorced from globalization? I think not. I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold. ...

There are many convoluted definitions of globalization. Mine is simple: Economic potential is no longer defined or contained by political and geographic boundaries. ... Where does monetary policy come into play in this world? One of the first books I read as I prepared for my new job as Dallas Fed president was A Term at the Fed... by former Federal Reserve Governor Larry Meyer. ... Meyer’s book is a real eye-opener because it describes in great detail the learning process of the FOMC ... as the U.S. economy morphed into the new economic environment of the second half of the 1990s. At the time, economic growth was strong and accelerating. ... The prevailing views ... pointed to rising inflation. That is precisely what the Federal Reserve’s models were saying, as was Meyer himself, joined by nearly all the other Fed governors and presidents ... Under the circumstances, they concluded that monetary policy needed to be tightened to head off the inevitable.

They were frustrated by Chairman Greenspan’s insistence on postponing rate hikes, yet ... inflation ... kept falling. If the conventional wisdom had prevailed, the Fed would have caused the economy to seriously underperform. ... Greenspan ... was ... constantly talking ... to business leaders. And what they were telling him jibed with what he knew ... new technologies ... enhanced productivity. ... It is important to listen to our economy’s business operators. ... Our business managers are the nerve endings in Adam Smith’s invisible hand...

The ... creation of vast new sources of inputs and production have upset all the calculations and equations of the very best economics minds. How can economists quantify with precision what the United States can produce with existing labor and capital when we do not know the full extent and elasticity of the global labor pool? Or the totality of the financial and intellectual capital that can be drawn on to produce a nation’s GDP? How do we measure the inventory-to-sales ratio in a technologically advanced, hyper-interconnected world where offshore sources are expanding geometrically, if not exponentially? ...

The old models simply no longer apply in our globalized, interconnected and expanded economy. ... the economics profession needs to rejigger its econometric equations to better inform our understanding of the maximum sustainable levels of U.S. production and growth.

There are, of course, those who will argue, at least from a theoretical perspective, that globalization should not matter much in a world of flexible exchange rates. They contend that a central bank can tailor monetary policy to domestic objectives alone when it is not obliged to defend a specific value for the currency. ... The proposition, however, holds only under assumptions I do not think apply in the world we live in today. ... To be sure, not everyone buys into my proposition ... Even so, as a practical matter, globalization has important implications for monetary policymakers, flexible exchange rates or no. ...

Will the tailwinds stay with us? Left to their own devices, I think they would ..., but we have to take into account the political dimension. I have expressed my concern about the implications of our fiscal deficits, vowing never to use my vote on the FOMC to monetize excess spending. I have also warned of the dangers of protectionism...

As a Texan, I am mindful of the story about William McChesney Martin, Fed chairman from 1951 to 1970. President Johnson invited him down to his Texas ranch for what turned out to be a one-on-one meeting. The president wanted a more accommodating monetary policy, and Martin, a strong advocate of Fed independence, tried to explain to him the consequences of that course of action. Johnson would have none of it and advanced on Martin, shoving him around the room and shouting, “Boys dying in Vietnam, and Bill Martin doesn’t care!” Years later, Martin expressed his regrets about shifting policy to suit the president. “To my everlasting shame,” he said, “I finally gave in to him.”[1]

Presidents Clinton and Bush have allowed the Fed to operate with a high degree of political independence from the administration. On the whole, Congress has also wisely refrained from interference. Without its independence from political interference, I doubt the Fed could have so successfully set the interest rates that have led to today’s favorable economic circumstances. Just as I doubt that, without independence from rigid econometric dicta, monetary policy could have so adroitly harnessed, and in turn lubricated, the forces of globalization.

"Boys dying in Iraq and Ben Bernanke doesn't care!" I trust Bernanke will withstand any such pressure.

    Posted by on Saturday, January 7, 2006 at 12:32 AM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (19)

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