WEBVTT NOTE Inner Workings of the Fed 1 00:00:00.000 --> 00:00:04.000 Our next speaker is Dr. Peter Klein. Peter, why don't you come up here? 2 00:00:09.000 --> 00:00:14.000 Peter is a professor of economics at, excuse me, teaches economics at the University of Missouri, 3 00:00:14.000 --> 00:00:22.000 also taught at the University of Georgia, teaches in Copenhagen, the author or the editor of five books. 4 00:00:22.000 --> 00:00:28.000 But I want to mention one new thing about Peter and make an announcement that he's going to be joining the Institute 5 00:00:28.000 --> 00:00:31.000 in the Institute as our Executive Director. 6 00:00:31.000 --> 00:00:34.000 I'm looking forward to having him come to Auburn. 7 00:00:34.000 --> 00:00:41.000 I'll just tell a couple of stories. 8 00:00:41.000 --> 00:00:48.000 I remember this was in 1988 when Peter was leaving Chapel Hill 9 00:00:48.000 --> 00:00:53.000 and going to get his PhD at Berkeley and wrote to the Institute for some help. 10 00:00:53.000 --> 00:00:56.000 And I read his letter and Judy Thomason is our publications editor, 11 00:00:56.000 --> 00:00:59.840 ," he reminded me the other day of just how a gog I was when I saw this letter and I immediately 12 00:00:59.840 --> 00:01:03.320 called Murray Rothbard and I said, Murray, I've just gotten the most extraordinary letter 13 00:01:03.320 --> 00:01:08.320 from a student I've ever seen and may I fax it to you and if you agree with me, would you 14 00:01:08.320 --> 00:01:15.080 talk to Peter? So Murray was very excited, he did indeed talk to Peter and Peter was 15 00:01:15.080 --> 00:01:22.560 very close to Murray, to the late Bert Blomert, who was our chairman at that time and I could 16 00:01:22.560 --> 00:01:29.440 Tell many other stories about Pete Otis, mentioned one other, as a postdoc you spent a year internship 17 00:01:29.440 --> 00:01:33.600 with Bill Clinton's Council of Economic Advisors. 18 00:01:33.600 --> 00:01:39.120 So about four or five months after he finished his year in Washington, I get a visit from 19 00:01:39.120 --> 00:01:43.000 a local FBI agent. 20 00:01:43.000 --> 00:01:47.200 He's wanting to check out Peter's bonafides and see if he's a security risk because he's 21 00:01:47.200 --> 00:01:48.520 going to have this internship. 22 00:01:48.520 --> 00:02:06.980 Thank you so much, Lew. Thanks to all of you for being here. It's been my privilege and 23 00:02:06.980 --> 00:02:11.940 honor to be associated with the Mises Institute for many years since my graduate school days 24 00:02:11.940 --> 00:02:17.940 and I'm delighted for the opportunity to join the staff and to continue to work with all 25 00:02:17.940 --> 00:02:28.340 My remarks today on the inner workings of the Fed are based on testimony that I gave 26 00:02:28.340 --> 00:02:34.260 in May of this year to the Domestic Monetary Policy and Technology Subcommittee of the House 27 00:02:34.260 --> 00:02:36.020 Financial Services Committee. 28 00:02:36.020 --> 00:02:39.820 That's the subcommittee, of course, headed by Ron Paul. 29 00:02:39.820 --> 00:02:46.100 It was a very interesting day to spend with the congressmen on the committee. 30 00:02:46.100 --> 00:02:55.100 There are a number of distinguished panelists, including Professor Jeff Herbner, who's a professor at Grove City College and also a senior fellow of the Mises Institute, 31 00:02:55.100 --> 00:03:06.100 John Taylor, a very famous monetary theorist from Stanford University, some of you have heard of the so-called Taylor Rule for monetary policy associated with Professor Taylor, 32 00:03:06.100 --> 00:03:14.100 Alice Rivlin, who's a long-time Brookings Institute scholar, former Vice Chair of the Board of Governors of the Federal Reserve System, 33 00:03:14.100 --> 00:03:18.100 somewhat less sympathetic to the views that Professor Herbiner and I purported. 34 00:03:18.100 --> 00:03:29.100 And the fifth member of the expert panel was the liberal polemicist James Galbraith, son of the well-known polemicist John Kenneth Galbraith. 35 00:03:29.100 --> 00:03:35.100 So you can imagine that a variety of views were presented on this panel on the nature of the Federal Reserve System. 36 00:03:35.100 --> 00:03:40.640 System, and possible improvements to the Fed and to the institution of central banking 37 00:03:40.640 --> 00:03:41.640 more generally. 38 00:03:41.640 --> 00:03:48.060 Now, as you know, under Representative Paul's leadership, the House Financial Services Committee 39 00:03:48.060 --> 00:03:54.460 and this subcommittee in particular has been somewhat more aggressive in addressing fundamental 40 00:03:54.460 --> 00:03:59.060 issues of monetary theory and policy than had been the case before. 41 00:03:59.060 --> 00:04:03.020 So a number of distinguished scholars have testified before that committee, including 42 00:04:03.020 --> 00:04:33.020 Professor Salerno on an earlier occasion. Professor Herbner was with me as well, both discussing some of the technical details of monetary theory and policy. And so when I appeared before the committee, I thought rather than repeat what my fellow previous and one of my fellow panelists was saying, I would focus on a slightly different aspect of the Federal Reserve system and central banking more generally, not only how it works in theory, and what 43 00:04:33.020 --> 00:04:38.380 What actions the Fed has recently taken and the harm that these actions have done to the economy. 44 00:04:38.380 --> 00:04:42.140 But a little bit about how the Fed operates in practice. 45 00:04:42.140 --> 00:04:49.100 The Fed, of course, is an institution filled with staffers from the chairman on down. 46 00:04:49.100 --> 00:04:51.180 It's like all other human institutions. 47 00:04:51.180 --> 00:04:54.580 It has its foibles and its quirks and its peculiarities. 48 00:04:54.580 --> 00:04:56.780 So what is it that the Fed actually does? 49 00:04:56.780 --> 00:04:59.420 How does the Fed actually work? 50 00:04:59.420 --> 00:05:06.820 Or from the perspective of organization theory, management theory, the principles of organizational 51 00:05:06.820 --> 00:05:13.800 governance, how is the Fed operated, how is the Fed organized, how is it managed, how 52 00:05:13.800 --> 00:05:18.860 is it governed, what are its objectives, what are the formal objectives, what are its informal 53 00:05:18.860 --> 00:05:24.820 de facto objectives, how is it structured, what kinds of incentives do people working 54 00:05:24.820 --> 00:05:32.780 How are they evaluated, monitored, governed, disciplined? 55 00:05:32.780 --> 00:05:34.700 Do they face any competition? 56 00:05:34.700 --> 00:05:36.660 Do they have any external check and balance? 57 00:05:36.660 --> 00:05:44.300 Well, of course, you know the answers to most of these questions already. 58 00:05:44.300 --> 00:05:48.960 The Federal Reserve, like other central banks, is an economic planning agency. 59 00:05:48.960 --> 00:05:53.100 Central banks are government, or what they call quasi-government entities, with a legal 60 00:05:53.100 --> 00:05:59.340 Legal Monopoly on Monetary Policy, in some cases Fiscal Policy, de facto, working hand 61 00:05:59.340 --> 00:06:03.180 in hand with the fiscal authority, the Treasury and the U.S. case. 62 00:06:03.180 --> 00:06:09.260 Many countries, the Fed also has a legal monopoly on bank regulation. 63 00:06:09.260 --> 00:06:14.860 These organizations are headed by political appointees and usually staffed with civil 64 00:06:14.860 --> 00:06:19.700 servants, technocrats from prestigious universities like Princeton, I'm sorry Steve to bring that 65 00:06:19.700 --> 00:06:20.700 up again. 66 00:06:20.700 --> 00:06:30.200 They are nominally independent of the political process, so imagine that you have an agency, 67 00:06:30.200 --> 00:06:38.580 an organization with vast discretionary authority, headed by smart and ambitious people with 68 00:06:38.580 --> 00:06:43.980 almost zero oversight, governance, no checks and balances. 69 00:06:43.980 --> 00:06:50.360 What would you expect an organization like that to do, to be very conservative, keeping 70 00:06:50.360 --> 00:07:04.360 is intervening its activities very limited, intervening only when absolutely necessary, performing up to the task exactly as mandated. 71 00:07:04.360 --> 00:07:13.360 Of course you wouldn't expect that at all, right? Even well-intentioned, well-educated, nominally competent individuals placed in a situation like that 72 00:07:13.360 --> 00:07:21.360 would have the temptation, the ability to engage in whatever kinds of interventions they desired. 73 00:07:21.360 --> 00:07:25.360 And of course, that's exactly what we've seen throughout the history of central banking, 74 00:07:25.360 --> 00:07:28.360 particularly the Federal Reserve system in the United States. 75 00:07:28.360 --> 00:07:37.360 I mean, if nothing else, the Fed, under Chairman Bernanke's leadership, has been particularly innovative. 76 00:07:37.360 --> 00:07:44.360 Now, when we talk about, you know, in the private sector, we have a big Apple store just a block or so down the street on 5th. 77 00:07:44.360 --> 00:07:52.360 We like it when Apple is innovative, right? We like it when research organizations like the Mises Institute are innovative. 78 00:07:52.360 --> 00:08:00.360 Do we want government entities with their vast authority and without any external check to be innovative? 79 00:08:00.360 --> 00:08:06.360 Well, I mean, I think that question sort of answers itself if you think about monetary policy in particular. 80 00:08:06.360 --> 00:08:11.600 So remember that organization like the Fed, what are the things that the Fed is authorized 81 00:08:11.600 --> 00:08:17.120 to do, that the Fed is tasked, tasks that the Fed has to perform? 82 00:08:17.120 --> 00:08:25.320 Well, the Fed controls the monetary base, sets the discount rate, sets reserve requirements, 83 00:08:25.320 --> 00:08:31.480 acts as a lender of last resort, regulates bank lending and other bank activities. 84 00:08:31.480 --> 00:08:38.120 And in the United States since the 1980s, you have the so-called dual mandate, where 85 00:08:38.120 --> 00:08:45.520 the Fed is charged with maintaining stable prices and maintaining full employment. 86 00:08:45.520 --> 00:08:51.640 Now these are of course impossible tasks for any central planning agency to perform, and 87 00:08:51.640 --> 00:08:57.480 they're certainly tasks that we would not want a central planning agency even to attempt. 88 00:08:57.480 --> 00:09:03.840 But remember that the way the mandate has been interpreted and the way these tasks have 89 00:09:03.840 --> 00:09:09.160 been enumerated is in a way that de facto gives the Federal Reserve system the authority 90 00:09:09.160 --> 00:09:12.700 to do almost anything that it wants. 91 00:09:12.700 --> 00:09:20.060 So when you look at the Fed's balance sheet, David Stockman talked about the sheer magnitude 92 00:09:20.060 --> 00:09:25.220 of the Fed's balance sheet, but also if you look at the composition of the balance sheet, 93 00:09:25.220 --> 00:09:32.620 The Fed, by custom, until Chairman Bernanke, invested exclusively in U.S. Treasury bills, 94 00:09:32.620 --> 00:09:37.140 and there's language in the Federal Reserve Act requiring the Fed to invest in these particular 95 00:09:37.140 --> 00:09:39.300 safe, quote-unquote, assets. 96 00:09:39.300 --> 00:09:42.180 But there's an emergency escape clause. 97 00:09:42.180 --> 00:09:48.740 There's a clause in the legislation that allows the Fed to own other assets under extreme 98 00:09:48.740 --> 00:09:55.900 In extreme emergencies, under special circumstances, the Fed may trade in other kinds of securities. 99 00:09:55.900 --> 00:10:04.180 Well, of course, that's a loophole wide enough to drive a Manhattan-sized city bus through. 100 00:10:04.180 --> 00:10:08.300 So of course, the Fed has taken advantage of this loophole to invest in the so-called 101 00:10:08.300 --> 00:10:11.820 toxic assets and to purchase any kind of securities that it wants. 102 00:10:11.820 --> 00:10:17.300 So essentially, Bernanke can intervene in financial markets in any way that he wants, 103 00:10:17.300 --> 00:10:21.300 in any way that he wants. 104 00:10:21.300 --> 00:10:28.860 Now I needn't belabor this audience with details of the financial crisis. 105 00:10:28.860 --> 00:10:34.140 The green span Bernanke credit bubble, the relaxation of underwriting standards that 106 00:10:34.140 --> 00:10:39.180 Walter Block already discussed, TARP and the bailouts and so on, the injection of trillions 107 00:10:39.180 --> 00:10:44.180 of dollars into the US economy by Chairman Bernanke and, of course, his predecessor, 108 00:10:44.180 --> 00:10:50.580 Zero Interest Rates and so on. You know, quantitative easing now, quantitative easing tomorrow, 109 00:10:50.580 --> 00:10:57.360 quantitative easing forever, as David Stockman reminded us. And of course the effect of virtually 110 00:10:57.360 --> 00:11:04.840 every action the Fed has taken since 2008 has been to perpetuate exactly those structural 111 00:11:04.840 --> 00:11:10.260 imbalances that constitute the financial crisis and the recession to begin with. Of course 112 00:11:10.260 --> 00:11:14.980 First, what the Fed has done is precisely the opposite of what the Austrian School economists 113 00:11:14.980 --> 00:11:18.900 would prescribe for such an emergency. 114 00:11:18.900 --> 00:11:23.980 When malinvestments are revealed, the most effective course, the course that is best for 115 00:11:23.980 --> 00:11:28.940 the economy in the short to medium run and certainly in the long run, is to liquidate 116 00:11:28.940 --> 00:11:34.700 these malinvestments, to free up these resources and get them reallocated to higher valued 117 00:11:34.700 --> 00:11:37.620 uses as quickly as possible. 118 00:11:37.620 --> 00:11:42.700 And of course every action taken by the Fed, of course the US Treasury and other agencies 119 00:11:42.700 --> 00:11:48.540 since 2008 has been to perpetuate the malinvestments, to make sure that the structural imbalances 120 00:11:48.540 --> 00:11:52.140 remain as long as possible indeed forever. 121 00:11:52.140 --> 00:11:56.020 But I don't want to talk to you now about these specific policy moves because most of 122 00:11:56.020 --> 00:12:00.660 you are familiar with them and they have been addressed and will be addressed by other speakers 123 00:12:00.660 --> 00:12:01.660 too. 124 00:12:01.660 --> 00:12:05.780 Really what I want to talk about is sort of the Fed as a central planning agency more 125 00:12:05.780 --> 00:12:08.380 more generally, right? 126 00:12:08.380 --> 00:12:14.000 Now most economists, most decent economists, understand that central planning is not an 127 00:12:14.000 --> 00:12:18.300 effective way of organizing the economic system. 128 00:12:18.300 --> 00:12:22.380 So whether they be from the Chicago school or sort of modern technocrats trained at 129 00:12:22.380 --> 00:12:31.500 MIT, all but a few, you know, hardened socialist economists understand that markets are better 130 00:12:31.500 --> 00:12:35.140 ways of allocating resources than government planners. 131 00:12:35.140 --> 00:12:39.900 But for some reason, with the exception of the Austrian School, most economists believe 132 00:12:39.900 --> 00:12:47.900 that money and the monetary system constitute exceptions to this general principle. 133 00:12:47.900 --> 00:12:54.140 They argue that for the monetary system, for money and for the banking system, it's essential 134 00:12:54.140 --> 00:13:01.820 to have a single decision-making body with vast discretionary authority, with no competition, 135 00:13:01.820 --> 00:13:07.020 of course for its own services, limited oversight, effectively no oversight whatsoever to what 136 00:13:07.020 --> 00:13:12.580 this planning agency will do, almost unlimited authority within its sphere, and that this 137 00:13:12.580 --> 00:13:19.980 agency should be run by an apolitical, sorry, an elite core of apolitical technocrats, like 138 00:13:19.980 --> 00:13:23.820 you know, distinguished professors from Princeton University, and of course Ben Bernanke was 139 00:13:23.820 --> 00:13:29.620 a very distinguished mainstream monetary scholar before his appointment at the Federal Reserve 140 00:13:29.620 --> 00:13:37.620 System. Now, of course, to an Austrian economist, this is a recipe for disaster. This is a recipe 141 00:13:37.620 --> 00:13:42.780 for disaster. Everything that we know about economic planning, about centralized economic 142 00:13:42.780 --> 00:13:50.620 planning, tells us that planners, if they have the wrong theoretical model in mind, 143 00:13:50.620 --> 00:13:56.620 they lack the information to be effective within their assigned sphere, they have no 144 00:13:56.620 --> 00:14:02.140 No incentives to make decisions that are in the interest of the economy as a whole, there's 145 00:14:02.140 --> 00:14:08.100 no market test for their services, no matter how well-intentioned a central planner may 146 00:14:08.100 --> 00:14:09.100 be. 147 00:14:09.100 --> 00:14:13.860 And I'm not claiming that our current monetary central planners are well-intentioned, but 148 00:14:13.860 --> 00:14:20.340 even if they were, such a setup cannot possibly be an effective way of allocating resources 149 00:14:20.340 --> 00:14:21.500 in an economy. 150 00:14:21.500 --> 00:14:27.120 If anything, if the collapse of central planning in the Soviet Union and the Eastern Bloc and 151 00:14:27.120 --> 00:14:35.700 Communist China has taught us anything, it's the lessons of Mises and Hayek and Rothbard 152 00:14:35.700 --> 00:14:37.300 have been vindicated by history. 153 00:14:37.300 --> 00:14:44.060 I was speaking to one of our participants here during the break, what can we do? 154 00:14:44.060 --> 00:14:48.980 Is there a way that we could demonstrate to our fellow citizens and to policymakers the 155 00:14:48.980 --> 00:14:56.580 and the Superiority of Free Markets Over Central Planning with a small colony or with some 156 00:14:56.580 --> 00:15:00.820 enterprise zone kind of experiment, well, I mean, I think that would be terrific. 157 00:15:00.820 --> 00:15:07.420 But anyone who cannot see already that central planning has failed in every instance that 158 00:15:07.420 --> 00:15:12.900 it's been tried will not be convinced by any experiment that we've performed tomorrow. 159 00:15:12.900 --> 00:15:17.460 The lessons of history are glaringly obvious and, of course, we have the theories of Mises 160 00:15:17.460 --> 00:15:19.620 and his followers to explain to us 161 00:15:19.620 --> 00:15:22.780 exactly why central planning does not work. 162 00:15:22.780 --> 00:15:25.300 For some reason, people think that money, 163 00:15:25.300 --> 00:15:27.660 economists, many economists think that money 164 00:15:27.660 --> 00:15:30.700 and the monetary system is an exception to this rule. 165 00:15:30.700 --> 00:15:34.220 Now, those who favor central banking, 166 00:15:34.220 --> 00:15:36.540 some of those who favor central banking, of course, 167 00:15:36.540 --> 00:15:38.820 have been critical of specific moves 168 00:15:38.820 --> 00:15:41.040 by this chairman or that chairman. 169 00:15:41.980 --> 00:15:44.540 There's a lot of debate in the technical literature 170 00:15:44.540 --> 00:15:46.900 and the policy literature about things like 171 00:15:46.900 --> 00:15:50.660 so-called inflation targeting versus nominal income targeting. 172 00:15:50.660 --> 00:15:56.260 My old professor and Obama advisor, Christina Romer, is a proponent of nominal income targeting 173 00:15:56.260 --> 00:15:59.180 by the Fed instead of inflation targeting. 174 00:15:59.180 --> 00:16:04.260 Should the Fed's dual mandate be repealed with the Fed tasked only with maintaining 175 00:16:04.260 --> 00:16:09.580 stable prices and not responsible for full employment? 176 00:16:09.580 --> 00:16:12.060 These are nibbling around the edges. 177 00:16:12.060 --> 00:16:16.780 These are trivial issues relative to the central issue of whether we should have the Federal 178 00:16:16.780 --> 00:16:18.780 and the Federal Reserve System at all. 179 00:16:18.780 --> 00:16:23.780 Walter Block mentioned Milton Friedman's fixed money growth rule. 180 00:16:23.780 --> 00:16:29.780 So Friedman, of course, thought that the government should control money, 181 00:16:29.780 --> 00:16:34.780 that we should have fiat paper money, but the government should be restricted 182 00:16:34.780 --> 00:16:37.780 in its ability to print money effectively. 183 00:16:37.780 --> 00:16:45.780 The fiat government money supply should grow at a fixed rate, 3% per year, 2.5% per year. 184 00:16:45.780 --> 00:16:52.320 Professor Taylor has come up with a version of this argument where instead of a fixed 185 00:16:52.320 --> 00:16:58.300 rate there should be a formula, a mathematical formula that is public and transparent according 186 00:16:58.300 --> 00:17:03.140 to, you know, you take the employment rate and some other macroeconomic aggregates and 187 00:17:03.140 --> 00:17:08.500 you plug them into a formula and that tells you how fast the money supply should increase. 188 00:17:08.500 --> 00:17:16.280 The point of these sorts of reforms is to constrain the ability of the Fed to intervene 189 00:17:16.280 --> 00:17:19.500 actively in the economy. 190 00:17:19.500 --> 00:17:25.620 The debate is usually framed about rules versus discretion, that discretionary monetary policy 191 00:17:25.620 --> 00:17:31.140 creates uncertainties, it gives the Fed the authority to intervene in ways that are harmful. 192 00:17:31.140 --> 00:17:37.060 Why not tie the Fed's hands by asking it to abide by fixed rules? 193 00:17:37.060 --> 00:17:43.620 Well, if you like fixed rules, I have one that's even better than a legislative, statutory-mandated 194 00:17:43.620 --> 00:17:46.480 growth rate of a fiat currency. 195 00:17:46.480 --> 00:17:51.160 And that's to have commodity money, right, such as the gold standard, to take the monetary 196 00:17:51.160 --> 00:17:56.240 system completely out of the hands of central planners, right? 197 00:17:56.240 --> 00:18:00.280 It's like Doug French's example with the nuclear power plant, you know, you don't build the 198 00:18:00.280 --> 00:18:05.720 nuclear power plant and then try to constrain the actions of the nuclear power plant's operators. 199 00:18:05.720 --> 00:18:09.720 Well, don't do this and don't do this, we're going to give you a policies and procedures 200 00:18:09.720 --> 00:18:14.000 manual to try to make sure you don't, you know, blow us all to kingdom come. 201 00:18:14.000 --> 00:18:18.000 Well, a better solution if you're worried about that is not to build the plant in the 202 00:18:18.000 --> 00:18:19.620 first place. 203 00:18:19.620 --> 00:18:23.680 You don't get a bomb ready and then tell people, please don't set it off, right? 204 00:18:23.680 --> 00:18:25.920 It's better not to have the bomb in place at all. 205 00:18:25.920 --> 00:18:30.800 If you like fixed rules over discretion in the conduct of monetary policy, well, why 206 00:18:30.800 --> 00:18:36.640 Why not have a monetary system that is completely outside political and technocratic interference 207 00:18:36.640 --> 00:18:37.640 whatsoever? 208 00:18:37.640 --> 00:18:42.520 And that's exactly what proponents of the gold standard would favor, and that's why 209 00:18:42.520 --> 00:18:44.520 it's favored. 210 00:18:44.520 --> 00:18:46.320 What about guys like the chairman, right? 211 00:18:46.320 --> 00:18:49.000 I mean, I don't know Ben Bernanke personally. 212 00:18:49.000 --> 00:18:51.800 For all I know, he is well-intentioned. 213 00:18:51.800 --> 00:18:58.100 He certainly has the technical training that give you all the plaudits in the academy. 214 00:18:58.100 --> 00:19:04.780 The problem is not Ben himself. Let me give you an example. Back in 2008 when the Troubled 215 00:19:04.780 --> 00:19:09.940 Assets Relief Program, or the TARP, was being discussed, there were to their credit a number 216 00:19:09.940 --> 00:19:15.300 of economists, mainstream economists and Austrian economists, who were critical of the TARP. 217 00:19:15.300 --> 00:19:21.720 They said that, well, maybe bailing out these failing financial institutions is not exactly 218 00:19:21.720 --> 00:19:26.020 setting up the right system of incentives, we're worried about moral hazard and so on. 219 00:19:26.020 --> 00:19:32.740 It's a very interesting essay written by Greg Mankiw, who was a former chair of George 220 00:19:32.740 --> 00:19:37.540 W. Bush's Council of Economic Advisors, a very well-respected economist, professor 221 00:19:37.540 --> 00:19:42.640 at Harvard, and a pretty good economist on most microeconomic issues. 222 00:19:42.640 --> 00:19:47.180 Ben Bernanke had the following to say about the economists who were critical of the TARP. 223 00:19:47.180 --> 00:19:52.580 A group of economists had circulated an open letter critical of the chairman, saying that 224 00:19:52.580 --> 00:19:54.620 the TARP didn't sound like a good idea. 225 00:19:54.620 --> 00:20:00.380 Here's what Greg Mankiw said, I know Ben Bernanke well. 226 00:20:00.380 --> 00:20:05.820 Ben is at least as smart as any of the economists who signed that letter or are complaining 227 00:20:05.820 --> 00:20:10.300 on editorial pages about the proposed policy. 228 00:20:10.300 --> 00:20:13.980 Moreover Ben is better informed than the critics. 229 00:20:13.980 --> 00:20:18.000 The Fed staff includes some of the best policy economists around. 230 00:20:18.000 --> 00:20:23.340 In his capacity as Fed chair, Ben understands the situation. 231 00:20:23.340 --> 00:20:29.080 If I were a member of Congress, Mankiw goes on, I would sit down with Ben privately to 232 00:20:29.080 --> 00:20:34.540 get his candid view. If he thinks the bailout is the right thing to do, I would put my qualms 233 00:20:34.540 --> 00:20:42.220 aside and follow his advice. So, you know, just imagine Representative Paul going into 234 00:20:42.220 --> 00:20:47.220 Bernanke's office and saying, Ben, what should we do? I, you know, I put my qualms aside 235 00:20:47.220 --> 00:20:55.120 and go with you, Ben. I mean, this is, you know, it almost boggles the mind that any 236 00:20:55.120 --> 00:21:00.300 thoughtful person would think this is the right way to handle economy-wide central planning. 237 00:21:00.300 --> 00:21:06.140 You make sure the guy in charge is smart and has a good staff. You ask him what he thinks 238 00:21:06.140 --> 00:21:12.460 we should do and that's what we do, okay? There was a paper by another, by the economist 239 00:21:12.460 --> 00:21:18.420 Lawrence Ball recently, an NBER working paper, all about the psychology of the chairman, 240 00:21:18.420 --> 00:21:24.980 the psychology of Bernanke. Ball was trying to understand why some policies pursued by 241 00:21:24.980 --> 00:21:31.780 the Bernanke Fed are a little different from what Bernanke espoused as a Princeton professor. 242 00:21:31.780 --> 00:21:35.280 Why hasn't he done the things that he said the Fed should do when he was writing as an 243 00:21:35.280 --> 00:21:36.280 academic? 244 00:21:36.280 --> 00:21:45.120 The ball's proposed explanation is that Bernanke is kind of shy and withdrawn in meetings and 245 00:21:45.120 --> 00:21:50.000 he lets others dominate the discussion and he sort of fell victim to group think at some 246 00:21:50.000 --> 00:21:52.960 of the meetings of the open market committee and so on. 247 00:21:52.960 --> 00:21:57.920 I mean, look, why on earth would you want a monetary system? 248 00:21:57.920 --> 00:22:02.440 Why would you want a system in which the most important markets in the economy, the financial 249 00:22:02.440 --> 00:22:08.800 markets are subject, you know, their control and manipulation is subject to the personality 250 00:22:08.800 --> 00:22:14.080 of one guy. Right? I mean, we want a monetary system where we could care less what Bernanke's 251 00:22:14.080 --> 00:22:18.920 personality is, right? He's stuck in his office at Princeton teaching and he can be shy or 252 00:22:18.920 --> 00:22:25.640 aggressive and nobody cares. Putting that much authority in the hands of one guy where 253 00:22:25.640 --> 00:22:29.520 the outcome depends on his personality, I mean, that's not an economic system that I 254 00:22:29.520 --> 00:22:37.520 You know, I discussed in my testimony some of the controversy over the so-called independence of the Fed. 255 00:22:37.520 --> 00:22:46.520 A lot of economists have said, well, Ron Paul's push to audit the Fed and calls to make the Fed more transparent are problematic 256 00:22:46.520 --> 00:22:54.520 because then you'll have Congress in charge of monetary policy, and that's worse than having Ben Bernanke in charge of monetary policy. 257 00:22:54.520 --> 00:23:01.360 I mean, I'm not so sure, of course, what the defenders of independence mean by independence 258 00:23:01.360 --> 00:23:07.360 is lack of any external constraint. And of course, I certainly do not want the average 259 00:23:07.360 --> 00:23:15.360 congressman deciding the value of my money. But asking sort of an elite core of technocrats 260 00:23:15.360 --> 00:23:20.840 to decide the value of my money is not much of an improvement in my view. Again, as I 261 00:23:20.840 --> 00:23:29.840 What we want is a monetary system in which the value of my money is independent both of the whim of Congress and the whim of the technocrats. 262 00:23:29.840 --> 00:23:42.840 Now, as an intermediate step, my view is that the bill to audit the Fed or moves to make the Fed more transparent would certainly be substantial improvements. 263 00:23:42.840 --> 00:23:53.340 The fear of congressional interference is highly overblown, I think, relative to the value that would come from opening up the secret books and finding out what the Fed is actually doing. 264 00:23:53.340 --> 00:24:01.840 The popular outrage could likely be enough to constrain the Fed in ways that it is not constrained now. 265 00:24:01.840 --> 00:24:07.560 You know, the whole idea of the Fed as a lender of last resort is, of course, another problem 266 00:24:07.560 --> 00:24:13.760 with government monetary systems that have that kind of policy over their banking system. 267 00:24:13.760 --> 00:24:19.760 The theory of moral hazard, what economists call moral hazard, explains how all of us, 268 00:24:19.760 --> 00:24:24.880 when protected from any harmful consequences of our actions, will take different actions 269 00:24:24.880 --> 00:24:30.440 than we otherwise would. We'll be less cautious, more reckless. We won't think through the 270 00:24:30.440 --> 00:24:37.360 and the potential consequences of our decisions if the consequences fall on somebody else. 271 00:24:37.360 --> 00:24:45.080 I discussed in my testimony the improvements that would follow from eliminating the Fed's 272 00:24:45.080 --> 00:24:52.960 role as the lender of last resort which prompted the statement from Dr. Rivlin that a banking 273 00:24:52.960 --> 00:24:58.000 system without a lender of last resort would be bizarre. So she thought this was a bizarre 274 00:24:58.000 --> 00:25:10.240 The usual argument that you hear is that, well, unlike other kinds of businesses, banks 275 00:25:10.240 --> 00:25:15.400 and financial institutions are closely linked to each other through derivatives and other 276 00:25:15.400 --> 00:25:21.240 kinds of complex financial transactions, and the failure of one bank could bring down the 277 00:25:21.240 --> 00:25:28.840 and the entire system. To which I would point out, in a complex, modern economy, almost 278 00:25:28.840 --> 00:25:34.320 all industrial firms are closely linked to other industrial firms through complex networks 279 00:25:34.320 --> 00:25:42.240 of transactions, contracts, partnerships, alliances and so on. I mean, if you ask people, well, 280 00:25:42.240 --> 00:25:50.520 do you think that, say that the Nike Corporation is really in financial distress, if Nike were 281 00:25:50.520 --> 00:25:55.480 were to go bankrupt. Well, I mean, that could put some, that could pose a problem for some 282 00:25:55.480 --> 00:26:01.200 of Nike's suppliers, for some of Nike's customers, for other apparel manufacturers with whom 283 00:26:01.200 --> 00:26:06.640 Nike has contractual relations. But, you know, we don't think this would somehow bring down 284 00:26:06.640 --> 00:26:12.040 the entire shoe industry or bring down the retail clothing industry such that we need, 285 00:26:12.040 --> 00:26:26.840 A shoemaker of last resort to step in and supply the shoe liquidity that the market clearly needs. 286 00:26:26.840 --> 00:26:37.320 So in conclusion, if you design a government planning agency, even within not an economy-wide 287 00:26:37.320 --> 00:26:43.380 Planning Agency, but one that is tasked specifically with the conduct of monetary policy and bank 288 00:26:43.380 --> 00:26:45.840 regulation and so forth. 289 00:26:45.840 --> 00:26:52.840 You make this a government agency without any competition, immune from any sort of oversight, 290 00:26:52.840 --> 00:26:58.260 without any kind of external governance or constraint, and you give it effectively an 291 00:26:58.260 --> 00:27:03.720 unlimited mandate to manage the system as it sees fit. 292 00:27:03.720 --> 00:27:09.520 The results, predictably, will be the kind of catastrophe that we have seen in the last 293 00:27:09.520 --> 00:27:13.800 several years and we're seeing now and even more so with yesterday's announcement. 294 00:27:13.800 --> 00:27:21.760 The kind of monetary system that we do want is one in which the value of money, the characteristics 295 00:27:21.760 --> 00:27:27.460 of money, what goods and services constitute money, the form in which monetary exchange 296 00:27:27.460 --> 00:27:33.480 takes place, the monetary calculations of entrepreneurs, where all of these are independent 297 00:27:33.480 --> 00:27:40.840 not only of political interference, but independent of technocratic interference as well. 298 00:27:40.840 --> 00:27:45.000 So I say to Professor Bernanke, you know, thank you for your service. 299 00:27:45.000 --> 00:27:49.960 Please return to your office at Princeton University where you can, you know, espouse 300 00:27:49.960 --> 00:27:55.760 your doctrines to an audience of undergraduates rather than having your hand on the controls 301 00:27:55.760 --> 00:27:57.880 of the entire U.S. economy. 302 00:27:57.880 --> 00:27:58.880 Thank you very much. 303 00:27:58.880 --> 00:28:00.880 Thank you very much.