The Fed Isn’t Interested in Our World

Federal ReserveMatt Yglesias brought my attention to something really interesting yesterday, Ben Bernanke’s Biggest Mistake. It contains more information from the recent dump of FOMC transcripts. But this one paints the Fed in an especially bad light that is unfortunately not at all surprising.

It focuses on the 16 September 2008 meeting—just after Lehman Brothers went bankrupt. At that time, the Effective Fed Funds Rate was still at the relatively high 2%. Right now it is at 0.07%—effectively zero. So there is relatively little that the Fed can do to help the economy. But in September 2008, the Federal Reserve had a lot of power. They could have helped the economy by lowering interest rates. In fact, the markets were expecting them to do just that. Instead they did… nothing.

As Yglesias points out, this potentially had very negative effects on the economy:

When the stock market tumbled 4.71 percent the day after the meeting and kept falling through the week, the predominant interpretation came to be that policymakers had underestimated the harm done by allowing Lehman to fail, leading down the road to TARP and other bailouts. Another interpretation: They underestimated the harm done by ignoring clear and unequivocal evidence that the situation called for looser monetary policy. Markets were expecting a rate cut. The data pointed to a rate cut. But rates were not cut.

What the transcripts show is that the Fed board just wasn’t interested in what was happening to the economy generally. They were focused on what was happening to the banking industry. And that was important. But they didn’t seem to care at all about unemployment. September 2008 was the inflection point from the relatively low unemployment before the crisis to the high levels after it. But it didn’t matter because unemployment never really matters to the Fed.

Matt YglesiasThey had the data that indicted exactly what was happening. As Yglesias puts it, “In other words, inflation was down, the labor market was down, and the dollar was up.” So this isn’t even the usual case where the Fed is willing to do something about unemployment but only if it absolutely won’t cause inflation to tick up, which makes the power elite angry. In this case, they knew that inflation wasn’t a problem. And they did nothing, I think because it just didn’t matter to them.

Let’s look at it from the opposite perspective. If the Fed had information that inflation was about to explode, they wouldn’t have been complacent. They wouldn’t have figured that they could deal with it later when it actually happened. They would have understood that stopping inflation before it starts makes it easier to combat that waiting until it is a problem. They would have understand that allowing inflation to become a problem would cause unnecessary pain. But when it came to unemployment, it didn’t matter. In the month after they decided to not raise interest rates, unemployment went up 0.4 percentage points. Over a half million workers lost their jobs. And it allowed the whole economy to race into a recession that could have been slowed by a brisker response.

The issue, however, is not that proper action by the Fed would have improved the situation a great deal. The issue is that as we already know, the Fed is not focused on the regular economy. Their primary concern is for the power elite: Wall Street and the big banks. And in this case, even with plenty of data indicating that they should take action and lower interest rates, they ignored the concerns of the regular economy because they were so focused on the power elite.

Yglesias also provides a bit of Fed apologetics by noting that “it would be a stretch to say that FOMC members were indifferent to the basic economic situation.” I don’t think it is a stretch at all. They were concerned that the whole infrastructure of their world was falling apart. The fact that “their world” doesn’t include much of “our world” is a huge problem that we see from the Federal Reserve every day—crisis or no.

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About Frank Moraes

Frank Moraes is a freelance writer and editor online and in print. He is educated as a scientist with a PhD in Atmospheric Physics. He has worked in climate science, remote sensing, throughout the computer industry, and as a college physics instructor. Find out more at About Frank Moraes.

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