Betting Against the Fed

Steve Hanke
Campaign For Liberty
Sunday, August 30, 2009

The federal reserve is scrambling to convince the public that it is not a secretive institution that acts at the behest of Wall Street, but the public isn’t buying the Fed’s line. According to a Gallup Poll conducted in mid-July, the Fed received the lowest approval rating of the nine government agencies and departments evaluated–even lower than the Internal Revenue Service.

Trying to show the softer side of the central bank, Fed Chairman Ben S. Bernanke took us on a tour of his hometown of Dillon, S.C. on a 60 Minutes segment in March, and in July he fielded questions from newsman Jim Lehrer and an auditorium full of people for more than an hour in a televised town hall meeting.

Both events were carefully choreographed–and unprecedented. During his face time Bernanke explained many things, including the Fed’s strategy for shrinking its balance sheet and withdrawing the ocean of excess reserves from the banking system. Unfortunately, he did not address my main beef with the bank: that it clings to a flawed inflation-targeting regime with a horrible history of monetary policy failures.

In pursuit of inflation targeting–the idea that monetary policy should be geared to keeping the annual core inflation rate in a range of, say, 0% to 2%–the Fed has been much more tolerant of inflation than it has of deflation. In November 2002 then governor Bernanke and then chairman Alan Greenspan misdiagnosed a benign cyclical dip in the price level. Fearing deflation, the Fed panicked, and by July 2003 pushed the Fed funds rate down to a then record low of 1%, where it stayed for a year, allowing a flood of liquidity to hit the economy and the housing bubble to inflate. The Fed ignored economic theory developed by Austrian economists such as Nobel laureate Friedrich Hayek, who demonstrated that there was such a thing as a “good deflation,â€