Why the Federal Reserve Needs to Get Its Act Together

Federal Reserve Yellen
Manuel Balce Ceneta/APFederal Reserve Chair Janet Yellen
By John Mason

NEW YORK -- It's unbelievable, the position that the Federal Reserve is in right now.

As the markets wait for the results of the U.S. central bank's policy setting meeting this week, there has been a "destabilizing period of uncertainty over the Fed's intentions" and "weeks of mixed signals from the central bank," according to an article Sunday in the Financial Times.

This situation calls into question Fed Chair Janet Yellen's leadership and highlights the need for the Fed to get its act together.

True, some of the current uncertainty and complexity in the global economy is due to the behavior of China and other emerging-market nations. But the Federal Reserve has been a big contributor, too, with its three rounds of quantitative easing. And the Fed's attempts to provide financial markets with "forward guidance" have been a disaster.

A decision to raise short-term interest rates has been on the Fed's menu since it ceased its quantitative easing programs last October. The Fed was going to start raising short-term rates in the first quarter of this year. Then it was going to raise them in June. Then, for sure, in September. As each meeting approached, the noise surrounding the possible increase got louder and louder, and financial markets became more and more volatile.

The fear of many analysts is that a move by the Fed in current conditions will result in even more volatility. The chief economist at the World Bank has even said that a move on interest rates by the Fed could trigger "panic and turmoil" in emerging markets.

Others, attempting to quiet the markets, have suggested that the interest rate move being discussed is so small, only 25 basis points, and has been discussed for such a long time, that any Fed movement to raise rates will be a nonevent, a fait accompli.

The problem is that it should never have come to this.

The Federal Reserve has brought this burden upon itself. By creating market expectations, the Fed sets itself up for criticism if those expectations are not met. If expectations are not met a second time, the Fed just opens itself up for further criticism. And so on and so forth.

If Fed continues to act like this, then it will become clear that it doesn't understand leadership and is failing the economy.

Yes, the economy is at a new place, a place that it has never been before. Yes, over the past seven years or so, the Federal Reserve acted in a way it never had acted before. Yes, the Fed is going to have to use new thinking and new tools to move us on into the future. (Binyamin Appelbaum addresses these new tools in an article in The New York Times titled "Retooling the Fed for Liftoff.") The key issue going forward, however, is leadership.

Right now Federal Reserve policymakers look like a herd of cats. They don't seem to have any idea where they're going or any idea how they got here. And reliance on "data guidance" contributes little to leadership vision and market stability.

Yes, these are difficult, confusing times. Yes, there are a lot of problems out there in the world that must be taken into account. Yes, models that have been used in the past are incomplete or out of date.

Leadership must be exerted, however. The U.S. is still the No. 1 economic power in the world, and the U.S. economy is growing, while much of the rest of the world seems to be going in the opposite direction.

Speak With One Voice

In a complex economy, forward guidance isn't going to carry the day. Also, the Fed needs to speak with one voice for a while. Having several different members of the Federal Open Market Committee discussing their own views on random occasions doesn't help.

The Fed also needs to determine what it can and can't do. The Federal Reserve played a big role in preventing the Great Recession from becoming worse. It helped to sustain the banking system over the past seven years after several decades of "irrational exuberance" underwritten by the economic policies of the federal government.

The Fed can't do a whole lot in attaining faster economic growth. There was only so much that it could do anyway, but the credit inflation of the past 50 years taught the economy that it could earn more money through financial investment than through investment in plant and equipment.

Meanwhile, the global economy is changing, bringing on a new economic era. This new era is going to require new central bank goals. For example, Paul Volcker, former Federal Reserve chairman, has written in his book "Changing Fortunes: The World's Money and the Threat to American Leadership" that the price of a country's currency is the most important price in the economy of that country. Maybe the Fed should focus on the maintenance of a strong dollar. If Federal Reserve leadership doesn't establish its goals, express them clearly and firmly, and then act in a way that is consistent with achieving the goals, the discussion of Fed actions are going to become even more vocal and the markets are going to become even more volatile. The world can't afford that.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
Read Full Story