NOTE TO CHAIR POWELL: DITCH YOUR SKETCHY 2% SOLUTION!
At the Federal Reserve, it’s crunch time. Its chair, inflation hawk Jerome Powell, soon will tell the world whether he’ll impose yet another interest rate on a beleaguered nation.
Over the course of a few days in March, average citizens have been trying to digest the crash-landing of three U.S. banks, and another — First Republic — on life-support. It’s difficult to predict what it means for the rest of us, who don’t have more than $250,000 stashed away in an account insured by the Federal Deposit Insurance Corporation, and neither dally with venture capitalists nor deal in cryptocurrencies. However, it is clear that an economy that seemed to be doing okay now feels shaky.
There a lot of people to blame, including the folks who ran the banks, the people in D.C. who were supposed to supervise them, and of course Congress, which approved the Trump-era rollback of crucial bank regulations. But we might have to travel to New Zealand to track down all the culprits.
That’s because whatever was wrong at these banks was exacerbated by an unceasing barrage of interest rate increases imposed by the Federal Reserve to tamp down rising prices, making borrowing money more expensive, and reducing the value of “safe” investments like long-term government bonds. Silicon Valley Bank, the largest institution to fail, had to sell those bonds at a steep loss, in a failed attempt to raise enough cash to pay off all its customers, most of whom had deposits far exceeding what the Federal Deposit Insurance Corporation would cover.
New Zealand was the first country in the world to adopt 2% as an inflation target. Unfortunately, that number seems as sacred to Federal Reserve Chair Jerome Powell as the crucifix is to the pope.
As a Catholic, I often believe in things I cannot prove. The head of the Federal Reserve should have more stringent standards.
In the late 1980s, Roger Douglas, New Zealand’s former finance minister, gave a TV interviewer a ham-handed answer about the government’s aims to curb high inflation. The answer he confesses to have pulled “out of the air” was that the government would not tolerate inflation that rose above 1%.
On second thought, that figure didn’t seem too realistic. So, New Zealand put its benchmark for curbing inflation at 2%.
That’s it. Two percent is not the byproduct of hard thinking by capable economists. It wasn’t examined and re-examined and the subject of much debate. It evolved from a number literally pulled out of the air to satisfy a restive populace.
If a bunch of women officials did this, people would call it imprecise and flaky, based more on emotion and politics than science.
But white men in suits can get away with nearly anything. The New Zealand benchmark of 2% became a fad. A number of central banks, including those in the EU, the U.K, Japan, and the U.S. all adopted it.
But even then, at the Federal Reserve, it was kind of a secret sign, for insiders only. Federal Reserve Chair Alan Greenspan reportedly warned, “[I]f the 2% inflation figure gets out of this room, it is going to create more problems for us than I think any of you might anticipate.”
For 16 years, the Fed did not publicize that number. It was Fed Chair Ben Bernanke who actually made 2% the official inflation standard in 2012. But many economists didn’t agree, theorizing that a target of 3% or even 4% would be more viable.
A recent study by the Federal Reserve Bank of Cleveland also doubts the wisdom of the 2% solution. The study predicted that achieving the 2% inflation goal would cause unemployment to jump to more than 7%. Mike Konczal, Roosevelt Institute director of macroeconomic analysis, suggested there are many reasons why a larger inflation range of 2 to 3.5% makes more sense than the firm 2% the Fed is currently pursuing.
“The Fed has wanted to do stuff until something broke, and that something broke. And the next thing that breaks is that 2 million people are going to lose their jobs when the unemployment rate goes up,” Konczal told Vox after Silicon Valley Bank collapsed.
The bank meltdowns got the attention of the Fed, the FDIC, and the White House, and their quick action might prevent future disasters, or may actually encourage more risk-taking by some mid-sized financial institutions. Whatever happens in the future, the disasters are a clear and compelling signal that Powell and his colleagues should ponder.
Maybe, just maybe, since the lives and livelihoods of millions of Americans are at stake, Powell could pause a little and begin to rely on more you know — research — before killing the entire economy. Three bank failures are three too many.
