Ideological battle rages at heart of the Fed
WASHINGTON (AFP) – Like any good central banker, the Federal Reserve’s Ben Bernanke cut a calm figure Thursday, sketching an endgame for vast crisis lending without hinting at the ideological storm that engulfs him.
From behind a thick wooden desk, Bernanke assured Congress that the Fed would not raise interest rates or withdraw 2.3 trillion dollars it has used to prop-up the economy before the “appropriate time.”
What he did not tell assembled lawmakers and television crews was that economists, Washington policymakers and even his Fed colleagues are in fierce disagreement about when the appropriate time might be.
Experts say the worst economic crisis since the Great Depression has exploded a debate over monetary policy that has long bubbled within the Fed.
“To some degree we are in uncharted territory” said Rob Roy McGregor, an economics professor at the University of North Carolina, Charlotte and an expert on the Fed’s interest-rate setting Federal Open Market Committee.
Within the committee, McGregor said, monetary hawks — who argue for tight controls on money supply to curb inflation — are dismayed by historically low interest rates and the scale of Fed’s balance sheet, which is more than double pre-crisis levels.
Meanwhile monetary doves, facing the greatest economic crisis in a generation, are more willing than normal to run the risk of stoking inflation in the pursuit of job creation.
It is not the first time the Fed’s monetary hawks and doves have clashed, but today’s tough realities may be polarizing the debate.
In recent months, traces of that debate have become public, shattering the Fed’s image as a bastion of pointy-headed economists who pore over endless streams of data before reaching an amiable consensus.
For two straight committee meetings, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, has voted against his colleagues’ promise to keep interest rates low for an “extended period.”
That is a sure sign of wider discord within the normally guarded Federal Reserve, according to Vincent Reinhart, a former head of the Fed’s Division of Monetary Affairs.
“The first thing to remember is that Fed is a consensus-driven organization,” he said pointing to divisions over how quickly the Fed should move away from crisis mode by raising rates and unwinding the balance sheet.
“This is a philosophical issue: how they exit, and how quickly they want to exit,” he said, “it is fundamentally about how you think inflation is determined.”
According to McGregor, such dissent “is actually quite rare.” Between 1966 and 1997, dissent was recorded in just 7.8 percent of votes.
Some blame the politically-charged nature of the economic debate for the splits, and for threatening the Fed’s independence.
Allan Meltzer, a Fed historian and former economic advisor to presidents John Kennedy and Ronald Reagan, said the votes of open market committee members are often influenced by their proximity to Washington politics.
Of the ten voting members on the open market committee, five are members of the Fed’s Washington-based board of governors, and five are presidents of regional federal banks.
“The (regional) presidents are not as politically responsive,” said Meltzer, “they are out there talking to people, they hear the concerns about inflation.”
In the current economic environment, the governors may be more finely attuned to concerns in Washington about tighter monetary policy and fears that it could choke the economic recovery.
There are concerns that politics may further influence the debate. Obama now has the opportunity to appoint two vacant governors seats and replace the Fed’s vice-chair, who is to retire. All three would serve on the open market committee.
Meltzer sees a difficult balance between the two, sometimes conflicting prongs of the Fed’s mandate: to seek price stability and full employment.
“The Fed has a dual mandate, and they choose to fulfill one part of that mandate at a time.”