"The only way in which a human being can make some approach to knowing the whole of a subject is by hearing what can be said about it by persons of every variety of opinion and studying all modes in which it can be looked at by every character of mind. No wise man ever acquired his wisdom in any mode but this." -John Stuart Mill

Saturday, May 29, 2010

The Inflation Hawk

The Wall Street Journal’s “Weekend Interview” column recently featured a piece on Kansas City Federal Reserve Bank President and Federal Open Market Committee member Thomas Hoenig (pronounced “HAW-nig”), whom the article describes as the Fed’s “monetary dissident.” Hoenig has earned this label as a result of his lone opposition to the repeated decisions of the FOMC (the committee that sets U.S. monetary policy) to promise that interest rate targets will be held “exceptionally low” for an “extended period of time.” He has been the only member to cast a vote against such language at the committee’s last three meetings.

Hoenig’s dissent is ostensibly motivated by worries that excessively easy monetary policy will lead to the formation of asset bubbles that will precipitate future crises much like the one that recently wracked the U.S. financial system. Although he concedes that the causes of bubbles are somewhat poorly understood, Hoenig also acknowledges that when investors and speculators can borrow at extremely low cost, the chances that asset prices will rise at an artificially fast pace are increased: “when you have an extended period of time with very low interest rates… those are some of the necessary conditions that will enable very rapid credit expansion leading to bubbles, perhaps. At least the likelihood of bubbles is greater under those circumstances.”

Because the FOMC is comprised of professional economists who are relatively insulated from the ephemeral pressures of the political world, there is generally broad agreement within their ranks. Truly fundamental ideological conflict is rare, though the members can certainly be thought of as lying on a spectrum whose poles are the twin objectives that constitute the “dual mandate” of the Federal Reserve: full employment and long-run price stability. For example, UC Berkeley Professor Emeritus Janet Yellen, who is currently President of the Federal Reserve Bank of San Francisco and who sits on the FOMC ex officio, has argued that the Fed ought to be far more concerned with unemployment than inflation at present, and that deflation might even be a more worrying threat given current macroeconomic conditions.

In contrast, Hoenig has been described as an “inflation hawk” because of his countervailing views on how the Fed ought to order its priorities. He maintains that there is little reason to fear that tightening up monetary policy sooner rather than later would inhibit recovery, and that the costs of unintentionally triggering asset bubbles outweigh any potential benefits to be gained by pursuing an expansionary strategy for an “extended period.”

I have a great deal of respect for Hoenig. Whether his persistent criticisms of the consensus view of the FOMC are motivated by real concerns or by a simple contrarian tendency isn’t all that important. What is important is that Hoenig represents a pragmatic sort of intellectualism that is wary of allowing any conclusions to go unchallenged, but that is mature enough to grant that reasonable people can disagree about a particular issue without disagreeing about everything.

Although his inflationary warnings seem to find a more receptive audience on the political right than on the political left, Hoenig avoids extreme positions such as those of Congressman Ron Paul (R-TX), who wants to see the Fed scrutinized more closely by Congress and ultimately done away with entirely. In his interview with the WSJ, Hoenig says that “it would be a tragedy to politicize the Federal Reserve system in any way more than it already is,” and that “the balance of private/public was designed in 1913 specifically to make sure that there was some independence that would allow the Federal Reserve to conduct monetary policy with the long-term in mind.”

In other words, we can have debates about the best way to conduct monetary policy without having fruitless squabbles about whether we should be conducting monetary policy at all. Criticism and dissent are crucial components of any thoughtful discussion (let alone discussions whose outcomes affect the economy of an entire nation), but blanket disagreement for its own sake is petty and counterproductive. If only more of our leaders would realize that.

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