Opinion

Op-Ed: Time for the Fed to take the punch bowl away

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Opinion,Op-Eds

The Federal Reserve board meets this week for the first time in 2013. The question of whether to continue its "quantitative easing" will undoubtedly headline the agenda.

Last month, Chairman Ben Bernanke announced the central bank would extend the program -- continuing to purchase $85 billion in Treasuries and mortgage-backed securities each month until the unemployment rate falls below 6.5 percent. Since the announcement, the stock market has been on a tear, with security indexes such as Dow, the S&P 500 and NASDAQ approaching all-time highs. The Fed policy has also juiced up the price of bonds, land, precious metals and other commodities.

It is time for the Fed to take away the punch bowl and end this party. There is no question that ending quantitative easing will be difficult; however, the longer this policy is pursued, the more difficult it will be for the Fed to unwind this huge portfolio of assets.

Bernanke and a majority of the board will likely support extension of quantitative easing, at least until the end of the year. But others -- including Richmond Fed President Jeffrey Lacker -- favor ending this program. In fact, "several" board members said it would "probably be appropriate to slow or stop purchases well before the end of 2013." This debate will focus on the central bank's targets for inflation, unemployment and the pace of economic recovery. But the case for ending quantitative easing should extend to a broader set of issues relating to recent Fed policy.

Its advocates defend the policy on the grounds that traditional tools of monetary policy were inadequate responses to the financial crisis and, in particular, the collapse of the housing market. However, recent research calls that rationale into question.

According to a 2012 report by Stanford economists Johannes Stroebel and John Taylor, reliance on the traditional monetary tools of open-market operations and targeting overnight rates could have stabilized financial markets, including mortgage and credit, during the recent crises. Further, they reveal that Fed purchases of mortgage-backed securities had minimal impact in lowering mortgage rates. In fact, they may even run the risk of exacerbating the mortgage situation.

The Fed's expanded asset purchases have also virtually displaced some private credit markets, such as the interbank money market. The elimination of Fed asset purchases would pave the way for restoration of these private credit markets. It is especially important for the Fed to unwind its position in mortgage-backed securities. This would pave the way for restoration of private mortgage lending and decrease reliance on Fannie Mae and Freddie Mac.

Additionally, reliance on quantitative easing ignores the unique role that the U.S. plays in international financial markets. For most of the posWorld War II period, the U.S. assumed a leadership role in stabilizing international financial markets and promoting free trade. Recent Fed policies have destabilized those same markets. The term "beggar thy neighbor" is usually reserved for protectionist trade policies, but it is a good description of recent Fed monetary policy.

Not surprisingly, other countries have responded to recent Fed policy with their own monetary expansion, including asset purchases. These countries are no longer willing to watch their currencies appreciate and exports decline as a result of irresponsible Fed policies. Competitive currency depreciation has the potential to undermine international financial markets today, much as it did during the Great Depression.

Since the 2008 financial crisis, the Fed has pursued an unprecedented expansion of the money supply, and these monetary policies have financed unprecedented deficit spending and accumulation of debt. Amid the weakest economic recovery since the Great Depression, and facing projections of further sluggish economic growth, it is time to declare these Keynesian fiscal and monetary policies a failure.

Continued reliance on these policies will result in a lost decade similar to that of the 1970s. A stable growth of the money supply, combined with the fiscal orthodoxy of balanced budgets, will allow the country to restore a higher trajectory of economic growth comparable with that achieved over the past two centuries.

Barry W. Poulson, a professor emeritus at the University of Colorado at Boulder, is past president of the North American Economics and Finance Association. He is also an adjunct scholar of the Heritage Foundation and a senior fellow of the Independence Institute.

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