Monday, September 28, 2009

'Too Big to Fail' Destoying the Effectiveness of the Fed   [Veronique de Rugy]

There is an interesting op-ed piece by Richard W. Fisher and Harvey Rosenblum in the Wall Street Journal this morning explaining how the Too Big To Fail (TBTF) policy is effectively destroying the Federal Reserve's ability to rescue the economy effectively. Like Christina Romer, Milton Friedman, Ben Bernanke, and others, the authors believe that until recently the Fed held the powers to get us out of severe recessions. But the politics of rescuing banks that shouldn't be rescued — even big ones — is jeopardizing this ability.

Since the TBTF Blob reduces the effectiveness of monetary policy's transmission mechanisms, unorthodox policies become the only recourse. These measures carry great risks. Don't do enough and the economy may descend into a deflationary spiral. Doing too much for too long may ignite an inflationary burst.

Holding the TBTF Blob at bay will help keep the conventional channels operational. Monetary policy will stay in the ideal middle ground, navigating small changes in inflation rates running in the low one-to-two percent range, where central bankers are most comfortable and economies perform at maximum efficiency.

The piece is interesting in that it shows how government interventions, long before the crisis, but even since the crisis hit in 2007 have made things worse, much worse. And how these interventions limit the range of options available contributes to make things even worse. It's a government-created spiral.

Read the whole thing here.

The piece comes off as relatively critical of CDSs and CDOs. I don't agree with Fisher and Rosenblum. Among other reasons, here is a very good piece by Mercatus’s scholar Houman Shadab on "Credit Default Swaps and Regulatory Reforms."

09/28 11:44 AMShare