The Fed and The Long Run

I used to hurry a lot, I used to worry a lot
I used to stay out till the break of day
Oh, that didn't get it,
It was high time I quit it
I just couldn't carry on that way - The Long Run by The Eagles (1979)

Kansas City Federal Reserve President Thomas Hoenig gave a speech last week at the London School of Economics. What we heard as we read the speech was that Hoenig believes the Fed is focused too much on the short term effects of its policies and insufficiently on the longer-run unintended consequences. One quote stands out:

"A Swiss central banker once advised me that the duty of a central banker is to take care of the long run so the short run can take care of itself."

Thomas Hoenig is a voting member of the Federal Reserve's Open Market Committee. As such, he has been something of a lone voice in the wilderness lately by speaking - and voting - against the Fed's unusually accomodative interest rate stance as well as the second round of 'quantitative easing.' He has repeatedly shared his reasoning which we summarize as follows: Emergency measures taken during the credit crisis were necessary but continuing the emergency measures after the credit crisis passed invites adverse unintended consequences in the long run.

In fact, Hoenig takes a few moments during his speech to point out that it was the long-run unintended consequences of the Fed's overly-accomodative interest rate policy beginning in 2003 that fueled the massive credit expansion and housing boom. From his speech (which is well-worth reading):

"The crisis has sometimes been described as a “perfect storm” of unfortunate events that somehow came together and systematically undermined the financial system. Such events included, for example, weak supervision and a misguided national housing policy. While these factors certainly contributed to the severity of the crisis, monetary policy cannot escape its role as a primary contributing factor."

Moreover, in giving another example of long-run unintended consequences, Hoenig lays the recent rapid increase in commodity prices (and we would add to that the resulting unrest in the Middle East/North Africa) at the feet of the Fed's current overly accomodative policies.

The good news is the "long run" is not here yet. The Fed still has time to remove what Hoenig calls "highly accomodative" policies and replace them with merely "accomodative" policies.

As the Eagles sang
Well, we're scared, but we ain't shakin'
Kinda bent, but we ain't breakin'
in the long run

Also see: Hoenig Blames Fed for Rising Prices
Vivien Lou Chen
Bloomberg
March 30, 2011