The Wall Street Journal has been feuding with the Fed and Ben Bernanke for a long time. The WSJ editorial board has long criticized the Fed both for its excessive use of the money spigot and for its penchant for keeping it open too long – all the while assuring everyone that all was well. In the WSJ’s opinion, the Fed managed to miss the essential point earlier in the decade: that excess liquidity creates bubbles that pop with disastrous consequences. And the current disaster can laid at the Fed’s doorstep as far back as 2003. From today’s edition:
The Federal Reserve’s Open Market Committee meets today, amid a debate over how and when to remove the flood of liquidity it has poured into the economy in the last 18 months. Fed officials say not to worry, they’re as vigilant about inflation as ever — which is itself a reason to worry. We’ve all seen this movie before, when the Fed’s failure to act in time gave birth to the housing bubble and credit mania that eventually led to panic and today’s recession. Will it make the same mistake now?
We remember that 2003 debate because it turns out we played a part in it. The Fed recently released the transcripts of its 2003 FOMC meetings, and what a surprise to find a Journal editorial the subject of an insider rebuttal from none other than Ben Bernanke, then a Fed Governor and now Chairman. We had run an editorial on monetary policy on the same day as the Dec. 9, 2003 FOMC meeting, and Mr. Bernanke clearly didn’t take well to our warning about “Speed Demons at the Fed.”
We reprint nearby both Mr. Bernanke’s comments and our editorial from that day. Readers can judge who got the better of the argument, but far more important is what Mr. Bernanke’s reasoning tells us about the Fed today. Our guess is that it won’t reassure holders of dollar assets.
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Recall that by the end of 2003 the economy was well into recovery. Third quarter GDP growth had clocked in at 8.2% (later restated to 7.5%), and growth in all of 2004 would be 3.6%. The Bush tax cuts had passed in late May, providing a fiscal boost, and a month later the Fed had cut its fed funds rate to 1% and would hold it there for a year. Yet by December Mr. Bernanke was still giving speeches fretting about “deflation,” even as commodity prices were rising and growth was kicking into higher gear. Thus our Dec. 9 warning, the first of many by us and others.Mr. Bernanke’s FOMC remarks that day are especially revealing about how he thinks about monetary policy. In particular, he dismisses any link between commodity price increases and future inflation. He cites a study by a Fed economist claiming to find little connection between “materials” prices and overall inflation. Yet the price of oil was already rising sharply at the time, and it would keep rising as the Fed maintained negative real interest rates for many more months. This was a bad mistake.
Rising gas and food prices didn’t show up in the Fed’s “core” inflation measurements, but they sure did wallop U.S. consumers this decade. It’s one reason Americans never felt great about the expansion. The soaring price of oil also contributed to the housing bubble by transferring wealth from U.S. consumers to oil exporters such as the Gulf States and Russia, which in turn recycled those petrodollars into U.S. Treasurys and mortgage-backed securities. By ignoring commodity prices, the Fed fueled the housing boom.
Read it all. When the history of this era is written, most of the blame for the current panic and depression will assigned the Fed. Without the bubble it created, none of the political or financial chicanery would have been possible.
And Bernanke is still with us – and apparently unconcerned about the dollar’s value.
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