Friday, February 02, 2007

Can someone please welcome Barney Frank to the 21st century?

Macroeconomics has come a long way since 1913, the year the Federal Reserve Act was passed. John Maynard Keynes' career was just getting started. Milton Friedman had just been born the year before. In fact, I'd wager that very few major theories pertaining specifically to macroeconomics that are still widely held today were developed before 1913. And yet, 1913 is the year the dual mandate for the Federal Reserve Bank was codified.

Macroeconomics has also come a long way since 1981, the year Barney Frank took office. This time not so much in terms of theory, but in practice. The U.S. was coming off two consecutive years of double-digit increases in consumer prices. The most recent presidential administrations thought price controls and jawboning would solve the inflation problem. Recent Fed chairmen Arthur Burns and William Miller seemed powerless to control inflation. Burns in fact believed that the Fed could not tighten monetary policy at a time when unemployment was rising, regardless of what prices were doing, as the population would not accept high levels of unemployment under the auspices of controlling inflation. So when both unemployment and inflation were on the rise in the 1970's, the Fed did very little.

For those of us in the investment business, and I'm sure for professional economists as well, 1981 must seem like another world. Many of the ideas that were given serious consideration (or even implemented) then to fight inflation would never be contemplated today. Paul Volcker and Alan Greenspan have proven through practice that controlling inflation and creating a more predictable inflation/interest rate world is better for everyone. It is also now widely held that the Fed has very little ability to improve unemployment in the short-term. While the Fed can increase the money supply to help alleviate a credit crunch or to prevent deflation, both academic research and the experience of the 1970's shows that easy money does not decrease unemployment.

Today, we hear Fed officials routinely state that the best way for the Fed to meet its dual mandate is to keep inflation low and stable. This allows business and consumers to plan better, and reduces the risks in the economy. That in turn allows more people to be employed.

The Wall Street Journal has an article today on inflation targeting, something I've been convinced is the right move for the U.S. central bank. Unfortunately, politicians like Barney Frank, who is chair of the House Financial Services Committee stand in the way. Even if you don't agree with me on inflation targeting, its pretty well settled that the Fed's dual mandate is best served by focusing on the "price stability" part and allowing the "maximum employment" part to resolve itself. If the economists at the Fed, who by all accounts are among the world's best in their field, say that an explicit inflation target is the way to achieve price stability, then why should a lawyer turned politician like Frank stand in the way?

Frank is widely considered among the most liberal of major U.S. politicians, but I don't see this as a liberal vs. conservative issue. Arguing that the Fed controls unemployment today is a little like debating whether steroids was pervasive in baseball. There may have been a legitimate case on both sides at one time, but now the answer is clear and well settled. Even if you once held the opposite position, the evidence now is so overwhelming that to continue clinging to your former position shows a lack of intellectual honesty.

I have no doubt that Barney Frank is a highly intelligent human being. So is Paul Sarbanes, who constantly argued a similar position from the Senate. I know there are other congressmen and women who have the same view as Frank. But it is both comical and frightening that such powerful people can be so misinformed about such a critical subject.


Anonymous said...

Sarbanes was a very pompous person who , in spite of education and intelligence , wasn't smart enough to look at points objectively ... he was so politically indoctrinated that he couldn't/wouldn't see the forest from the trees..... the Sarbanes -Oxley law is a great example of that--- he could never see the dynamics in an economy and people's reactions to laws , he believes that everything is static

Tom G. said...

The mighty Paul Sarbanes had been my senator for my entire professional life, and every time I went to a conference or whatever with other investment pros, somehow I always felt like I had to apologize for him. Especially post SOX.

Some people have been telling me off site that Barney Frank actually has a pretty good grasp of economics. I don't know the guy personally nor can I say that I've heard every thing he's ever said, so I'll defer to anyone who knows the guy better. But if that's true and yet he continues to spout off this dual mandate BS, then he's playing politics against good policy. That's entirely inexcusable.

Anonymous said...

I feel the same about Frank . While he's a bright guy ( thought not as smart as Sarbanes ) and has a good grasp of the issues , he too will play politics over policy every day of the week ....

such is life , unfortunately .... but at least Bush will use his veto power over anything remotely stupid