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Saturday, September 08, 2007

"It’s Monetary Policy, Not a Morality Play"

Tyler Cowen:

It’s Monetary Policy, Not a Morality Play, by Tyler Cowen, Economic View, NY Times: Wherever there are problems, people look for villains. The subprime mortgage crisis is a case in point. Hedge fund managers and speculators have been blamed for buying securitized loans heedlessly and spreading financial risk beyond the banking sector.

And since every villain must be punished, the Federal Reserve is being attacked as “bailing out the speculators.” Because it has injected additional liquidity into the economy, and kept short-term interest rates from rising, the Fed has been portrayed as a craven tool of the rich, in the pocket of Wall Street but neglecting the concerns of Main Street.

But financial markets rarely fit into simple moral narratives... Talk of a bailout is overstated. Some institutions have benefited from Fed policy, but the story is not a conspiratorial one: liquid markets are good for many investors, and if the Fed succeeds in keeping markets running, that helps hedge funds, too.

The Fed, for all its economic influence, cannot undo most investment mistakes. Bad mortgage loans, in particular, are of many years’ duration and won’t be made good by a temporary dip in short-term interest rates.

It is true that a more liquid short-term loan market can give a highly leveraged institution a second chance. An immediate infusion of cash can be a lifeline for a solvent, but illiquid, company. But keeping loan markets open is not a bailout; it’s simply getting part of the economic infrastructure back on line, much as the police clear a road after a traffic accident. ...

Colorful interpretations of recent monetary policy abound, from both commentators and politicians. Depending on the storyteller, the policy reflects the triumph of the rich over the poor, an atonement for the sins of the Bush administration, a long-awaited comeuppance for the American economy, a continuing hangover from the dot-com bubble, or an inability of the professor (Ben S. Bernanke) to handle a real-world job (running the Fed).

Journalists are especially likely to embrace narratives, if only because their editors and their readers clamor for them. ...

Nonetheless, Fed watchers should resist the tendency to put all events into a simple or a morally plausible narrative. Monetary policy is a largely technical subject, and its ups and downs don’t usually fit into the kinds of emotion-laden stories that human beings apply to daily life. The “us versus them” tag registers in human memory, but monetary policy is not always or even usually about moral issues. As Freud famously noted, sometimes a cigar is just a cigar. ...

In the case of subprime mortgages, many investors did not foresee the risk of collateralized debt securities. In response to this crisis, the Fed has been trying to keep a steady hand and prevent a credit crunch. We don’t yet know how well the Fed has succeeded... And the storm has not yet fully passed. ...

Debating Fed policy in terms of strong moral narratives makes it harder for the Fed to do a good job. For instance, if interest-rate cuts are portrayed as a bailout for hedge fund managers, it’s harder for the Fed to cut interest rates, if that turns out to be the appropriate policy. ...

The American public has a hard-enough time understanding relatively simple economic issues like the benefits of free trade, much less the Fed or monetary policy. So if the picture sticks that the Fed is a shill for hedge fund managers, or that it is treating homeowners unfairly, the pressure will mount for Congress to limit the Fed’s independence. Yet most economists ... agree that relatively independent central banks have a better record of maintaining economic stability...

Wealthy financiers and hedge funds make for easy targets, especially when combined with the arcane field of central banking. But the real moral question is whether we will prove mentally tough enough. Can we resist the temptation to force financial markets and the Fed into oversimplified moral narratives? Or will we continue to blame Zeus for lightning strikes? ...

It's interesting how many libertarians and conservatives support active government intervention into the economy to manage short-run fluctuations in output and employment in this particular case. Welcome aboard, and I hope this thinking will extend beyond the financial sector to all sectors of the economy, beyond monetary policy to include fiscal and other policy tools, and extend to individuals who are also subject to shocks that can affect their economic well-being. With all the talk about how bailouts cause moral hazard, I hope we will remember that "policy is not always or even usually about moral issues" and give people the help they need when they lose a job, have a costly health problem, or their are other events that cause them economic difficulties.

There are always going to be people who try to take advantage of whatever system of help we have in place, and some will succeed and become poster children for the evil moral hazard that occurs when the people are protected from falling too far. We should, of course, try to minimize the opportunities to take advantage of the system, but just because a few people will take advantage is no reason to withhold help from the vast majority who do not need rules and regulations to stop them from finding ways to exploit the system. Maybe this is a holdover from grade school - I used to hate it when one or two kids who couldn't behave would prevent the whole class from doing fun things - but too often we forget that most people are not simply looking for a way to beat the system and take advantage of the kindness of others. Most people are just like you. When things go bad, they don't need to be taught a moral lesson they already learned long ago, they need help and we shouldn't hesitate to give it to them.

    Posted by on Saturday, September 8, 2007 at 01:53 PM in Economics, Monetary Policy, Social Insurance | Permalink  TrackBack (0)  Comments (35)


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