Business Insider

Peter Crabb: Bernanke successor unlikely to change Fed’s course

Peter R. Crabb
Peter R. Crabb

The old coach is retiring, and a member of his staff has been hired. Turns out she is using the same unsuccessful playbook.

Janet Yellen, the current Federal Reserve Board of Governors vice chair, was announced as the Obama administration's nomination to succeed Chairman Ben Bernanke. Yellen has already said she supports the Fed's current easy money policies. She further expressed deep concern about the nation's high unemployment, which suggests she may try to do more.

The financial markets responded favorably to the announcement. The expectation is that the Fed will keep short-term interest rates near zero and continue buying long-term bonds for some time now. While this may be good news for financial assets, it's unlikely to do anything for the real economy.

The Federal Reserve was created in 1913 in response to some late 19th century and early 20th century financial upheaval in the banking system. While stability of the financial system remains an important goal, the primary role of the Fed today is designing and implementing the monetary policy of the United States.

Monetary policy is any action undertaken by a central bank to influence the availability and cost of money and credit. Historically, the U.S. central, the Fed, used only three tools of monetary policy - open market operations, the discount rate, and reserve requirements. Low or zero interest rates are part of both open market operations and the discount rate, both of which influence banks' ability to provide credit.

Since the financial crisis of 2008, the Fed has taken monetary policy well beyond this short list of tools. Our central bank now operates in multiple sectors of the economy. The Fed recently announced continued support for mortgage- lending and housing markets with plans to purchase $40 billion of mortgage-backed bonds and $45 billion of U.S. Treasury securities every month.

Even if the federal government's debt limit is not raised this year, there will be plenty of bonds to buy. There is currently $11.6 trillion in publicly traded Treasury bills, notes and bonds, about $2.5 trillion of which is already held by the Fed.

Absent such market intervention by the Fed, the U.S. government would be forced to pay higher interest rates and devote more of the annual budget to servicing existing debt obligations. That is, without the Fed, federal-government spending would be restricted.

These unprecedented market interventions are likely to continue or expand under the new chairperson.

The policy-making committee of the Fed consists of 12 members - the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York and four of the remaining 11 Reserve Bank presidents, who serve one-year terms on a rotating basis.

With the appointment of Yellen, the vice chair position opens up, and the term for another member ends this coming year. More appointments from the president are coming. Expect any new members to share the new chair's favor for more monetary stimulus and bond-buying.

This is the Fed's playbook. Banks have been flush with cash for years now. Short- and long-term interest rates remain at historic lows. Despite these incentives, businesses don't want to hire and invest. A return to more normal monetary policy - higher bank interest rates and no intervention in financial markets - would be better for the economy.

Don't expect this from the new coach and her staff.