What if the FOMC and the wider Federal Reserve apparatus had heeded Greenspan’s uncertainty? There is grave danger in wandering too far into counterfactuals, but there is some value, I think, in the exercise in this context. What we are really talking about is time, and it is time that is most relevant today as the greatest economic cost. This current economy, the one which follows from the FOMC contemptuously ignoring Greenspan, including the Chairman himself, has already surrendered trillions because of it.
The Fed Chairman in June 2003 wondered quite pointedly whether monetary policy was as sharp as everyone at that table believed. They had great reason to doubt, though any doubts were often quite fleeting in that setting which encouraged only ideological rigidity. The economy was finding little recovery despite mild recession in 2001, and then the stock market that just wouldn’t stop crashing, all making a mockery of both the supposed “Greenspan put” as well as the power of monetary “stimulus.” The FOMC had voted eleven times for more monetary “accommodation” starting in January 2001; they brought the federal funds target down from 6.5% all the way to 1.75% in less than a year. And still they were stuck in 2003. If that didn’t unleash honest self-reflection then clearly nothing ever would (which is now proven fact).
Furthermore, the Bank of Japan had undertaken the world’s first ZIRP in the spring of 1999 and then QE in 2001 when they found ZIRP just wasn’t enough. The “Q” in quantitative easing proposes the kind of precision and authority that was commonplace at central bank sessions and discussions, a belief in their own abilities as something like actual scientists. That the Bank of Japan “had” to undertake a second QE just over a year after its first completely destroys the notion of “Q.” This point was not lost on the FOMC members in June 2003; they just had to work a little harder to suggest to themselves it was a defect of Japanese.
What Greenspan was actually saying at that momentous meeting was to, as I wrote last week, “make sure you can do what you say you can do before you have to do it.” The Fed never did as conditions suddenly changed seemingly for the better in 2003 to which the orthodox ascribed their own charmed hands. From that point forward through the rest of the housing bubble, the mania, the Fed believed it held a magic wand to cure all economic and financial ills – the quarter-point adjustments in the federal funds rate expertly executed and communicated by the most confident and assured professionals. They even believed this would hold as the housing bubble turned to bust, so misplaced and entrenched was this absurd idea.
What might have been accomplished instead had the FOMC taken the other path in June 2003? It would have followed into actual monetary research and the stark evolution of banking rather than the determined ignorance that we actually saw (shutting down M3 in 2006). But even if that had taken place, I find it unlikely that it would have made much difference on August 9, 2007, and for the next 18 months or so. That isn’t to suggest that a more learned FOMC might not have performed better and maybe even softened the blow, only that by the mid-2000’s I think it was already too late. The Committee would have understood far better what was going on, rather than erratically groping from onead hoc failure to the next, but that isn’t the same thing as actually being able to do anything useful about the imploding system.
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