In the midst of a loosening cycle, the Fed keeps the monetary base flat. This is not normal. Instead, they use their high-quality balance sheet to bail out the liquidity problems of banks, broker-dealers, and maybe others, all while not expanding high powered money. This is not normal, either. After all, the Fed wants to heal the providers of badly underwritten credit (and increased their efforts last week, also here, here, and here), but they don’t want any liquidity to spill over into the general economy, because it might spark a wage-price spiral.
Consider the efforts of the Treasury toward Fannie, Freddie, the banks, and the housing market generally. Yes, they are trying to avoid systemic risk, and that’s important. But where is the support from the Fed and Treasury over unemployment, which is beginning to grow currently. I’m not just talking about more unemployment, but about less compensation growth for labor in total. Their focus is away from that, and looking at stabilizing a financial structure. That’s good for all of us, but a disproportionate amount of the benefits goes to enterprises that made bad loans. My rules of bailouts say that you must make bailouts painful to management teams and shareholders, while protecting senior debt, and thus preventing systemics risk. That is not what is going on here.
I’m no great fan of central banking; I believe it makes our economy more stable in the short run, but intensifies crises when they take place (In my opinion, we never would have had the Great Depression if we had not created the Federal Reserve). Life under a true gold standard has real panics, but they are sharp and short.
At present, we are setting the stage for an increase in unionization. I am no fan of unions, but who can blame workers from seeking more bargaining power when they have had it rough for a long while?
My summary is that the policies of the Bernanke Fed are too clever. Restrain wage/price inflation while bailing out banks and broker-dealers, Fannie, Freddie, etc. But goods inflation keeps running ahead, and the oversupply of houses keeps forcing prices lower. The actions of the Fed and Treasury protect the financial system for now, but at what eventual cost? It might have been better for the Bernanke Fed to have been more traditional, and have stimulated the general economy, while letting the Treasury protect individual financial institutions in trouble.
I don’t think this will end well, but perhaps a recession like 1973-74 will clear the decks. The Fed has to see that its main roles are price inflation and unemployment, with systemic risk third. Any other way of prioritizing Fed action will lead to greater controversy in the long run.