In his latest letter, John Hussman writes about — what else — his utter contempt for the Bernanke, quantitative easing, speculative bubble-making, and all the standard ills that people ascribe to the the Fed.
An interesting point he makes is that Bernanke — by having made purchases other than plain vanilla US Treasury debt during QEI — essentially was practicing fiscal policy (rather than monetary policy) and was thus usurping powers specifically designated to Congress.
The reason this is particularly interesting now is that the Fed may yet again at some point feel pressure to go non-vanilla in its purchases (perhaps with more purchases of MBS or even state debt) which might constitute a practice of fiscal, rather than monetary policy:
A decade ago, Bernanke gave a speech titled “Japanese Monetary Policy – A Case of Self-Induced Paralysis?” where he encouraged the Bank of Japan to pursue “substantial currency depreciation,” “maintaining the zero interest rate policy for the indefinite future,” “stating an inflation target of, say, 3-4 per cent,” and if necessary, that “the BOJ expand its open market operations to a wider range of assets, such as long-term government bonds or corporate bonds.” Bernanke is essentially operating from this playbook, despite the fact that it has done Japan no good at all.
Some may argue that the first round of QE in the U.S. was effective, but to the extent it had an effect on the economy, that effect had nothing to do with monetary policy. What the Fed really accomplished during the first round of QE was the unlegislated grant of the government’s full faith and credit to Fannie Mae and Freddie Mac. As I noted last week, the public would have viewed Fannie and Freddie securities as indistinguishable from Treasury debt if Congress had explicitly guaranteed them, but Bernanke decided to substitute his own will for that of the public.
Bernanke’s 1999 speech included a very disturbing paragraph, particularly in light of what the Fed did by purchasing $1.5 trillion of these agency securities.
“In thinking about nonstandard open-market operations, it is useful to separate those that have some fiscal component from those that do not. By a fiscal component I mean some implicit subsidy, which would arise, for example, if the BOJ purchased nonperforming bank loans at face value (this is of course equivalent to a fiscal bailout of the banks, financed by the central bank). This sort of money-financed “gift” to the private sector would expand aggregate demand for the same reasons that any money-financed transfer does. Although such operations are perfectly sensible from the standpoint of economic theory, I doubt very much that we will see anything like this in Japan, if only because it is more straightforward for the Diet to vote subsidies or tax cuts directly. Nonstandard open-market operations with a fiscal component, even if legal, would be correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.”
Yet this is precisely what the Fed did with Fannie Mae and Freddie Mac a year ago. Bernanke understands this. He simply does not want the public or Congress to recognise it.
Given that fiscal authority is enumerated by the Constitution as the sole right of Congress, and spending is prohibited by the Constitution without explicit appropriation, it seems clear – regardless of how the Federal Reserve Act is written – that monetary operations involving anything but Treasury securities contain unconstitutional “fiscal component,” unless they involve repurchase agreements that would make the Fed whole even if the underlying securities were to fail. It is doubtful that when Congress drafted the Federal Reserve Act to allow the use of mortgage-backed securities, it ever dreamed that the Fed would purchase these securities outright when the issuer was insolvent. Until this issue is clarified in legislation, Bernanke will continue to see it as “perfectly sensible” for the Fed to make “money financed gifts” that substitute his own personal discretion for those of a democracy.
Equally disturbing is that Bernanke apparently has no problem confusing fiscal policy with monetary policy when it suits him. In the same paper, Bernanke purports to explain why the central bank always has the ability to increase aggregate demand, even in a liquidity trap:
“The general argument that the monetary authorities can increase aggregate demand and prices, even if the nominal interest rate is zero, is as follows: Money, unlike other forms of government debt, pays zero interest and has infinite maturity. The monetary authorities can issue as much money as they like. Hence, if the price level were truly independent of money issuance, then the monetary authorities could use the money they create to acquire indefinite quantities of goods and assets. This is manifestly impossible in equilibrium. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. This is an elementary argument, but, as we will see, it is quite corrosive of claims of monetary impotence.”
The only thing that is corroded here is Bernanke’s economic reasoning. In this example, the central bank is not engaging in monetary policy, but fiscal policy. Creating government liabilities to acquire goods and assets, unless those assets are other government liabilities, is fiscal policy, pure and simple.
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