Thursday, December 29, 2011

Note to Bloomberg: Sometimes it’s Quite Simple.

Speak up now or focus on other issues where you’re more knowledgeable.

Bloomberg Can Do Better” and “If Bloomberg Had Done it Right, They Could Have Been Heroes” discussed Bloomberg’s retrospective analysis of Fed policy during the financial crisis. As the titles of the postings imply, their analysis came up short. This blog has often been critical of Fed policy, but Bloomberg is wrong to criticize Fed policy during the liquidity crisis.

During a liquidity crisis success is easy to identify, especially after the fact. BARON’S put it fairly succinctly in “Bankers' Boon: Opening the Spigots Redux.” The relevant quote is: “Turn to the writings of Walter Bagehot, the 19th-century editor who wrote an early treatise on modern lender-of-last-resort theory—the basis for central banking. Bagehot differentiated liquidity-lending by making recipients pay up for the money, guaranteeing swift payback.”

The BARON’S article focuses on current policy. It is as critical of current Fed policy as this blog’s recent posting culminating in “Stimulus Can Backfire: Monetary Policy.” BARON’S focuses on the ultimate reason the current Fed policy is ill-advised: The Fed has tools that can remedy liquidity problems. When the problem doesn’t originate from liquidity, monetary policy can find itself “pushing on a straw.”

In Europe, the liquidity issues are the symptom not the cause. Monetary policy can accommodate a response, but the Fed isn’t the European Central Bank (ECB). Interestingly, the ECB recognizes that monetary policy should be a second tier player. Why can’t the Fed?

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