There is a really problematic misunderstanding of the Federal Reserve’s role in the economy brewing in this country. All of the sudden everyone on the internet is an expert about central banking and monetary policy. I blame this on Ron Paul and his supporters (I used to be one of these so I would know), gold traders and their hyperbolic advertising, and this wildly fallacious xtranormal cartoon on Youtube called “Quantitative Easing Explained”. This cartoon has gone viral. The two rounds of Quantitative Easing, or QE1 and QE2, are the Federal Reserve’s policies of monetizing US debt in order to pump liquidity into the banking system, and stimulate the economy and job growth. This cartoon purports to explain it, but really just expresses several fallacies that completely distort what is really going on. I am determined to defeat this cartoon. Please watch it below if you have never seen it before and read my response:
Here are some of the problems that I find in this cartoon’s explanation:
“Printing money is the last refuge of failed economic empires and banana republics.” Wrong. Open Market Operations (OMO) have been used by the Federal Reserve System, and other central banks from around the world, to “print money” and add liquidity to financial systems since before I was born. The claim about failed empires is hyperbole meant to invoke the specter of hyperinflation, but QE1 and QE2 are hardly to this extent. Remember, the hyperinflation of the Weimar Republic in 1920s Germany was 1 million percent, not the roughly two percent that we have now. By the way, it’s called “Quantitative Easing” because it is the process of adding liquidity to the financial system after interest rates have already been pushed to 0%. When the Fed uses OMOs to move interest rates it signals the market by setting a rates target, so given that there is no new target to set at a rate of 0%, it reports that it will add a specific quantity of dollars in liquidity. For example, the quantity in QE2 was 600 billion dollars over the course of 6 months.
Inflation is always bad, and deflation is good. Wrong. Optimum inflation is about 2% according to most economists, and deflation is never good. It is a fallacy to think that deflation is the people’s wages staying constant or rising, while the prices of goods and services they desire fall. This is not what deflation is. To learn more about what deflation actually is and why it’s bad, read my article “The Case against Deflation”. Also, for my 2011 inflation prediction, read my article “Inflation and the Cost of Thanksgiving Dinner”.
The criticism that the core Consumer Price Index (CPI) statistic does not include food and energy prices is not economically based, but populist based. The headline CPI number reported in the press does include food and energy, but core CPI is better for monetary policy decisions because it will pick up food and energy inflation if sustained. Food and energy prices are highly volatile due to many complex factors and interest rate policy should not be made highly volatile as well, just to appease a populist or ideological sentiment. Food and energy inflation is problematic for families I agree, but using monetary policy to address what is typically a demand, supply, or speculation problem, is just attempting price controls with a very inefficient lever, even for this misguided purpose.
“The Fed has been wrong about everything.” This is a superlative that does not fit the reality of how most economists and finance professionals view the Fed and its history. Problems are caused by humans for human reasons, not because of the proper workings of the institution. The Fed has often been successful at fixing its own mistakes, but this depends on who the Chairman is, or at what time in the business cycle it is and nature of the decline or boom. Also, forward looking public statements are always going to be politically massaged from the Fed because they move markets. Especially when these are statements made at the peak of a boom. If the Fed Chairman calls a bubble, and suggests it is certain to pop, it will be certain to pop, and become a self-fulfilling prophecy, and then he will have been correct just by virtue of saying it. I don’t want this sort of accuracy, do you? Fed Chairmen and other economic stewards don’t like getting blamed for popping bubbles, and so they will always try to sound as upbeat about the future as they can. This does not mean that they are wrong about the policies that they implement.
The Bernanke is called out for not having business or policy experience, but The Dudley is called out for working at The Goldman Sachs? That is contradictory. The Bernanke never ran an election campaign? This is completely irrelevant. Attempting to ruin the credibility of a serious academic and concerned steward of our economy using such tactics makes me suspicious. I don’t think the author of this cartoon knows much about Bernanke and has not likely read his work. Ben Bernanke is the Great Depression - Monetary Policy Guru in the US. Not hard to see why both Bush, Obama, and the financial sector have relied on him. He was Time’s 2009 Person of the Year because he was recognized by most economists to have saved the financial system from the brink of complete collapse. I know Ron Paul likes to call him a counterfeiter, but this is a politically charged and inappropriate metaphor, like calling Social Security a ponzi scheme.
All in all, this cartoon does not explain anything useful about the Fed, and only gives the illusion that one understands something about economics and monetary policy. The creator of this cartoon, Omid Malekan, said in an interview, “I made a video that takes a subject that’s normally in the hands of Phd’s and really, really old guys in expensive suits, and brought it down the level of two talking bears.” Yes, yes you did. It is much more complicated and counterintuitive than what you might think. Innocent bystanders, I encourage you to seek out an unbiased understanding of what the monetary policy tool is really about and how it compares to alternatives. Especially if you have been led to believe that a return to the gold standard is a good idea.
Jared Roy Endicott