Reblogged from Mostly Economics by Amol Agrawal
~~~~ “John Taylor has been criticising Fed since the crisis began(see this for a review). In another paper he criticised the US govt for overestimating the fiscal multiplier.
Taylor in a recent speech (at FRB Atlanta Conference) takes a critical overview of the entire govt policies in this crisis. He says:
Proposals for the future role of government in the financial markets depend critically on lessons learned about the role of government in the current financial crisis. Broadly speaking there are two views.
One view is that “the markets did it.” The crisis was due to forces emanating from the market economy which the government did not control, either because it did not have the power to do so, or because it chose not to. This view sees systemic risk as a market failure that can and must be dealt with by government actions and interventions; it naturally leads to proposals for increased government powers. Indeed, this view of the crisis is held by those government officials who are making such proposals.
The other view is that “the government did it.” The crisis was due more to forces emanating from government, and in the case of the United States, mainly the federal government. This is the view implied by my empirical research and that of others. According to this view federal government actions and interventions caused, prolonged, and worsened the financial crisis. There is little evidence that these forces are abating, and indeed they may be getting worse. Hence, this view sees government as the more serious systemic risk in the financial system; it leads in a different direction—to proposals to limit the powers of government and the harm it can do.
He then looks at the various govt interventions and says systemic risk is simply rising. The interventions have led to a rise in fiscal deficit risk which is just exploding.
He also does not like the Fed’s expanding balance sheet:
The second systemic risk is the Fed’s balance sheet. Reserve balances at the Fed have increased 100 fold since last September, from $8 billion to around $800 billion, and with current plans to expand asset purchases it could rise to over $3,000 billion by the end of this year. While Federal Reserve officials say that they will be able to sell the newly acquired assets at a sufficient rate to prevent these reserves from igniting inflation, they or their successors may face political difficulty in doing so. That raises doubts and therefore risks. The risk is systemic because of the economy-wide harm such an outcome would cause.
An example illustrates the risks in the current situation. According to a widely cited article appearing in the Financial Times two weeks ago, the Fed’s Taylor rule calculations show that the interest rate should be -5 percent. The article was based on a leaked report from the Fed. I have not seen the report and I do not know how the calculations were made, but they imply that the Fed may think it has plenty of time before positive interest rates and a reduction in reserve balances are required.
But the calculations are way off. The Taylor rule specifically says that the interest rate should be one and a half times the inflation rate plus a half times the GDP gap plus one. Whether you average a broad based GDP inflation index over the past year, as I originally suggested, or whether you use core inflation rates, the inflation rate is not less than 1 percent at this time; it is closer to 2 percent, but let’s suppose the Fed takes it as 1 percent. The GDP gap seems to be around minus 4 percent. Now, if we put those numbers into the rule, we get 1½ times 1, plus ½ times -4, plus 1, which equals .5 percent not -5 percent. The Fed’s calculation reported in the Financial Times has both the sign and the decimal point wrong. In contrast my calculation implies that we may not have as much time before the Fed has to remove excess reserves and raise the rate. We don’t know what will happen in the future, but there is a risk here and it is a systemic risk.
So, the guy who wrote the Taylor rule (though Taylor rule’s significance has been questioned in this crisis ) says Fed does not have much time.
He also adds govt should first rein in the govt induced risk. The much discussed systemic regulator will only work if we achieve the first objective.
But none of these tasks and objectives requires a new systemic risk regulator. Indeed, such a new entity—or even proposals for such an entity—might serve as an excuse for existing regulatory agencies to pass off responsibilities for past and future regulatory failures. And if it were given its own regulatory powers they would be very difficult to limit, especially if the regulator could define what was systemic and what was not. The experience during the panic last fall is not reassuring that such an agency could resolve private institutions without causing more systemic risks than it was trying to reduce.
I suggest that the tasks I mention here be done within the existing President’s Working Group on Financial Markets suitably expanded with the existing regulatory agencies and with funding to support sufficient staff at the Treasury to take on the tasks. Locating a systemic risk regulator at the Fed is not a good idea because it would interfere with its essential monetary policy objectives as explained clearly by Andrew Crockett.
But we should not expect too much. It is clear that a systemic risk regulator would not have prevented the current crisis. It would not have prevented the very low interest rates or the other government actions I have described in this talk. Nor would it be a force to reduce the major existing systemic risks, including the exploding federal debt, the Fed’s balance sheet, and the current bailout mentality.
This is so true. The systemic regulator would become the scapegoat in future crisis.
However, I still don’t agree that govts alone can be blamed. The markets/financial firms are also to be blamed. The financial oligarchy framework is equally powerful to explain the events (also read John Bogle’s view).” ~~~~
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