Throughout the years, the Fed has put forth many arguments to rationalize the growth of debt: excess liquidity is a result of Asian savings; financial innovations have allowed for more debt and faster GDP growth; asset growth has outpaced debt growth. While it may be appropriate for such arguments to be made by the private sector as it seeks to encourage more debt assumption, the fact that these arguments were being put forth by the Fed indicates a flaw in the current system. If the Fed was the institution justifying greater leverage, if the Fed was encouraging Americans to take on adjustable rate mortgages, if the Fed was its own apologist, what force in our society is the responsible counterbalance, the voice of reason encouraging a more sound financial sector, higher interest rates, and more savings with less debt?
Some Fed apologists may try to characterize the institution as a victim, having been unable to control the debt being created outside of its purview. While there is some truth to this line of thinking, it misses the bigger problem: the Fed has the biggest system-wide tool to encourage savings and to limit debt. Yet, for the last 20 years, by consistently lowering interest rates, the Fed has been using this tool to encourage more debt. The Fed has also encouraged deregulation, changes in CPI calculations, changes in reserve requirements, and the use of derivatives --- all of which help add more debt and leverage into the system. In addition, most Fed officials have engaged in actions and bailouts that fostered moral hazard and created an environment of risky behavior, as investors openly talked about how the Fed would come to the rescue should anything go wrong. In the end, it appears these investors were correct in their estimation.
Many short-term solutions to our current problems will be proposed. Some will be helpful. Other will only make the long-term problem worse by adding more debt than GDP. If we are to avoid the problems of the past, any long-term solution must add checks and balances to the Fed’s mandate to ensure appropriate levels of debt within our financial system. The Fed should be responsible stewards of the U.S. currency and conservative guarantors of the banking system.
"The Fed has also encouraged
"The Fed has also encouraged deregulation"
You can't have it both ways. You can't blame FED for both, regulation and deregulation. The FED is regulation. It is against free market. By deregulating, FED returns back to free markets.
So, we can say that we do not want FED at all, but we can't add that we hate for FED to be getting out of the business.
And if you believe that markets should be regulated, then FED is what you want. You can blame it for deregulating, but you can't add that you want FED to get lost.
Good point
cRavias,
"You can't blame FED for both, regulation and deregulation. The FED is regulation."
This is a very good point. My point is that I feel the Fed has an institutional bias to creating more credit and believing that credit growth is the solution and not the problem. As such, they deregulated in ways that encouraged more credit growth (e.g., allowing Glass-Steagall to fall by the wayside) but they kept up regulation in ways that encouraged more credit growth (e.g., lowering interest rates).
Since I believe that the natural rate of interest should have been higher and that credit growth should have been lower, I fault both the credit-inducing deregulation and the credit-inducing regulation.
In an ideal world, it would be much better to have less regulation in general and a greater reliance on the free markets. Agreed.