Does the Federal Reserve Bank needs to think bigger?

Just before the 4th of July, Fed leaders struggled to formulate a comprehensive solution to our nation’s economic problems. Atlanta Fed leader Dennis Lockhart proposed extending the Fed’s program of trading more short-term bonds for longer-term ones while Chicago Fed President Charles Evans criticized the extension of “Operation Twist,” by arguing that doing so would only reduce 10-year Treasury bonds by 1/10th of a percent. Fed leaders continue to present what they consider “balanced approaches” to using monetary policy as means for economic recovery, but fail to pinpoint what the right vehicle is.

That is why Carnegie Mellon economist Allan Meltzer believes that “to get out of our bad economic situation, we need coherent long-term fiscal policy, especially entitlement reform.” Meltzer contends that the Central Bank pays way more attention to the short term rather than the long term, and preachers what Nobel Prize Economist Milton Friedman proposed that “monetary policy operates in long lags.” He stresses that “the problem with the short term is that data reported for today is subject to revision, or reflect only transitory changes.” Meltzer criticizes Chairman Ben Bernanke for panicking when he shouldn’t have, charging Bernanke with the miss-handling of the banks’ $1.5 trillion extra in reserves, and sending much of the cash that banks received when the Fed freed up $600 billion to them in bond-buying overseas.

He believes that the bank’s use of the Phillips Curve is leading to a more inaccurate impression of the tradeoff between the inflation and unemployment rate, suggesting that the bank commit to using the Taylor Rule instead to better gage the interest rate accordingly. Meltzer concludes that “rule-based monetary policy” has brought our economy much better results in years past, and asks the Federal Reserve bank to stop counting on “politicians, the public, businesses and labor” to accept higher interest rates as an accepted force for economic recovery.

Posted By: Jonathan Sherman

Sources: The Wall Street Journal, Reuters

Photo Credit: The Fed 2 courtesy of Flickr user Adam Fagen

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