As I noted earlier this week, the past decade has provided a painful lesson in the limits of central banking. After failing to stop — and arguably helping to inflate — the housing bubble, the Federal Reserve failed to prevent the 2008 financial crisis, and then failed to engineer a strong economic recovery once the crisis had subsided. Many believe that better Fed policies could have averted the bubble and/or averted the crisis and/or delivered a stronger recovery.
We’ll never know for sure whether any of that is true. The Bernanke Fed certainly deserves credit for mitigating the economic fallout in 2008 and 2009. Indeed, it’s very possible, as Washington Post columnist Bob Samuelson recently observed, that Ben Bernanke and other central bankers helped the world avoid a second Great Depression. Yet the weakness of the recovery has reminded us that the Fed and its counterparts are not all-powerful economic-growth machines.
“An extended period of low interest rates,” writes economist Noah Smith, “accompanied by massive quantitative easing and forward guidance, didn’t seem to accomplish much; maybe it helped get inflation close to the Federal Reserve’s 2 percent target level, or it might have just been along for the ride.”
Clearly we need to revise our expectations of what Fed policy can actually achieve. Here’s Samuelson:
The old Fed is dead. The notion that it could orchestrate economic growth within narrow bounds was excessively optimistic and unrealistic. It may be, as economist Allan Meltzer of Carnegie Mellon University has long argued, that basic problems burdening the economy can’t be solved by increasingly large doses of easy money and credit. If too many rules and requirements thwart business start-ups, easy money is not a solution.
But the public may think it is. The Fed is now a prisoner of exaggerated expectations created in a friendlier era. If it fails to live up to those expectations, it may become the target of the public’s wrath. There are already signs of this. It will do no one any good to be angry at the Fed for things it can’t do.
Here’s another sobering thought: Given how much ammunition the Fed has used over the past eight years, what happens if, or when, the economy slides back into recession?
“Countering the next recession is the major monetary policy challenge before the Fed,” former U.S. Treasury secretary Larry Summers wrote last month. “I have argued repeatedly that (1) it is more than 50 percent likely that we will have a recession in the next three years (2) countering recessions requires four to five percentage points of monetary easing (3) we are very unlikely to have anything like that much room for easing when the next recession comes.”
A few weeks later, speaking at a Dallas Fed conference, Summers listed four ways in which America’s central bank could boost its credibility and/or help the economy. His suggestions are worth reading in full, as are Federal Reserve vice chairman Stanley Fischer’s recent remarks on the “causes and implications” of low interest rates.