MEMO TO THE FED: FIRST, DO NO HARM / THE WALL STREET JOURNAL OP EDITORIAL

Memo to the Fed: First, Do No Harm

Our central bankers should strive to limit or mitigate the collateral damage caused by their monetary policy.

By Jim Kudlinski    
          
June 14, 2015 6:14 p.m. ET

 

In the mid-1970s, Milton Friedman and I attended a board of directors meeting at the San Francisco Federal Reserve. He was there as an economic consultant, and I had flown in from Washington, D.C., on Fed business. After the meeting Friedman suggested we chat, and proceeded to give me a half-hour lecture on the difficulties inherent in conducting monetary policy. He concluded by asking me to tell then-Fed Chairman Arthur Burns and his colleagues to put all of their economic data in a computer and let the computer decide policy, because “when they do it, things get messed up.”

Friedman, who won the 1976 Nobel Prize in economics, believed that interventions in the market were disruptive—especially those by the Fed. Monetary policy produces imprecise results as well as ancillary outcomes. When the Federal Open Market Committee decreases interest rates, the cost of borrowing decreases but the return on fixed-rate investments also decreases, hurting seniors and other savers. Lower rates impact the Treasury’s cost of funds, stock-market valuations, bond prices, GDP and inflation. As then-Fed Chairman Ben Bernanke said in 2010: “Monetary policy is a blunt tool.”
 
Fed Chairman Paul Volcker, for example, ultimately succeeded in ending the “stagflation” of the 1970s, but the high interest rates needed to snuff out inflation brought their own economic pain—causing home builders nationwide to mail two-by-fours to him in protest of his incessant rate raising, and truckers to impede traffic in Washington, D.C., by parking their vehicles in strategic locations. While the Volcker Fed’s policies eventually succeeded, they raised fresh concerns over why so few unelected officials were able to create so much pain for so many.

Today’s prolonged near-zero interest rates and quantitative easing have provided a windfall to Treasury in funding the nation’s debt and propelled the stock market to record valuations. But superlow rates and QE have also distorted our markets, benefiting borrowers at the expense especially of seniors and others desiring reasonable returns from conservative investments. We are now in the eighth year of the Fed’s easy money yet growth remains anemic—as it is in the rest of the world employing similar tactics. Central banks continue to inflate asset values with money created from “nothing,” while economic theorists and others warn about impending difficulties in exiting from such a strategy.

There have been many legislative proposals to audit or otherwise constrain the Fed over the past four-plus decades. All have failed. Why? Their opponents have successfully focused on the independence granted to the Fed by the Federal Reserve Act of 1913 and cite it as one of the few government agencies that works.

This is why the two legislative proposals currently active also likely will fail: the Federal Reserve Accountability and Transparency Act, requiring the Fed to publish a “Directive Policy Rule” governing its monetary policy, sponsored by Rep. Bill Huizenga; and Sen. Rand Paul’s proposal to audit the Fed. Discontent with the Fed recently has increased but nowhere near the level required to penetrate its independence shield.

We have learned much since 1913, including that monetary policy is more art than science, and that it creates winners and losers. In 1977 Congress announced Fed mandates for monetary policy: maximum employment, stable prices and moderate long-term interest rates. In 2012 the Fed added to that list an inflation target of 2%.

I have a simple proposition. Physicians practicing medicine are expected to “first, do no harm.” Our practitioners of monetary policy should be expected to do the same. Congress should add to its Fed mandates the following language: “The Federal Reserve should strive to limit or mitigate the collateral damage caused by monetary policy, wherever possible.”

This new language would create additional accountability for the FOMC by requiring it to consider both the desired results anticipated and the collateral damage expected before implementing policy, and to report on such deliberations in its minutes—thus permitting closer oversight of the FOMC without an audit or otherwise infringing on the Fed’s independence.

About my visit with Milton Friedman and his message that we’d all be better off if we let a computer decide monetary policy: When I returned to Washington, I informed George Mitchell, then Fed vice chairman, of Friedman’s message. He just smiled.


Mr. Kudlinski, a former Federal Reserve official (1971-81), is the author of “The Tarnished Fed” (Page, 2014).