Lords of Easy Money

John Lim

THE FEDERAL RESERVE has a daunting responsibility. Among its jobs is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” This is commonly referred to as its dual mandate of maximum employment and price stability.

Yet those two aims are often at odds. That’s because of the inverse relationship between unemployment and inflation, embodied by the Phillips Curve. Attempts to maximize employment—or minimize unemployment—often stoke the flames of inflation.

The primary tool the Fed has to achieve its aims is the ability to set interest rates, specifically short-term rates. It’s a powerful tool because interest rates determine the cost of money. When interest rates are low, people and companies borrow more, leading to credit creation—and credit is the lifeblood of the economy.

In recent years, the Fed has expanded its monetary toolkit. Since the Global Financial Crisis of 2008, it has directly intervened in the bond market by buying longer-maturity Treasurys and mortgage-backed bonds. These interventions, known as quantitative easing or QE, drive the yields of longer-maturity bonds lower.

In addition to controlling a broad swath of interest rates, the Federal Reserve has greatly expanded the money supply through these bond purchases. Since 2007, real gross domestic product has increased by 27%, while the aggregate money supply—as measured by M2, which includes cash, checking accounts and other highly liquid assets—has jumped 300%.

The monetary might wielded by today’s Federal Reserve is truly unprecedented. Astonishingly, this power rests in the hands of just 12 individuals—the seven members of the Fed’s board of governors plus five Federal Reserve Bank presidents—who comprise the voting membership of Federal Open Market Committee (FOMC).

Despite its devilishly difficult task, FOMC members have a striking tendency to vote as a bloc. Dissension among committee members is usually rare. Indeed, since 1996, only two dissenting votes have been cast by Fed governors—the last one in 2005. Federal Reserve Bank presidents are a more rambunctious lot, having cast dissenting votes in a little over a third of FOMC meetings since 1996. Still, 63% of FOMC decisions have been unanimous since 1996.

Are the weighty matters before the Fed and its staff of 400 PhD economists just open-and-shut cases to these intellectual giants? Or is there more to the story?

Christopher Leonard’s new book, The Lords of Easy Money: How the Federal Reserve Broke the American Economy, sheds some light on this question. One of the central characters of the book, Thomas Hoenig, was the president of the Federal Reserve Bank of Kansas City from 1991 to 2011. While serving on the FOMC, he cast dissenting votes at all eight meetings in 2010, the only committee member to dissent that year.

Hoenig was under tremendous pressure to conform with the rest of the FOMC, then headed by Fed Chair Ben Bernanke. In 2010, quantitative easing had only recently been unleashed. The great worry was that any dissenting vote would weaken the case for QE by undermining the Fed’s authority. Bernanke and others felt it was imperative to present a united front.

What was on Hoenig’s mind when he cast the lone dissenting vote against a second round of QE in late 2010? Hoenig worried that the Fed was embarking down a road from which there was no turning back. QE, he believed, was a Pandora’s box that would be impossible to close. Furthermore, he feared that the easy money unleashed by QE would lead to risky lending and asset bubbles.

Hoenig wasn’t alone in his concerns. Regional Fed Bank presidents Jeffrey Lacker, Charles Plosser and Richard Fisher had doubts, too. As Lacker put it, “Please count me in the nervous camp.” Plosser’s assessment was more blunt: “I do not support another round of asset purchases [QE] at this time…. Again, given these very small anticipated benefits, we should be even more focused on the downside risks of this program.”

Unfortunately, Lacker, Plosser and Fisher were nonvoting members of the FOMC in 2010. I’m not arguing that the Fed was right or wrong to pursue quantitative easing. Rather, the apparent lack of psychological safety at the world’s most important financial institution is my concern.

What exactly is psychological safety? Amy Edmondson, a professor at Harvard Business School and an expert on psychological safety, defines it as a climate where people are comfortable expressing themselves without fear of reprisal or humiliation. In short, people feel safe speaking their mind.

In her wonderful book, The Fearless Organization: Creating Psychological Safety in the Workplace for Learning, Innovation, and Growth, Edmondson draws on decades of research to show that psychological safety is imperative for learning and managing risk. She points to the Wells Fargo account fraud scandal and Volkswagen’s “dieselgate” as prime examples. In both cases, an absence of psychological safety had disastrous consequences. These two corporate crises were enabled by an environment of fear—fear of not meeting impossible targets and fear of speaking the truth to leadership.

Hubris is antithetical to psychological safety, and it seemed the Fed suffered from a major case of hubris. An exchange between Fisher and Bernanke in 2012 is telling.

Fisher described how Texas Instruments was taking advantage of easy money by reconfiguring its balance sheet, issuing more debt instead of investing or hiring—one of the many unintended consequences of QE. Bernanke replied, “President Fisher… I do want to urge you not to overweight the macroeconomic opinions of private-sector people who are not trained in economics.”

I don’t know the state of psychological safety inside today’s Fed. But I do know that the Fed faces an economy that is as complex and uncertain as ever. Every voice inside the marble-white Eccles Building deserves to be heard and considered. Debate should not be stymied but rather encouraged. This includes garnering the views of “private-sector people who are not trained in economics.”

John Lim is a physician and author of “How to Raise Your Child’s Financial IQ,” which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.

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