The Fed: The Great Enabler

Abstract

The Federal Reserve has a long history of creating aggregate demand bubbles in the United States. In the ramp up to the Lehman Brothers’ bankruptcy in September 2008, the Fed not only created a classic aggregate demand bubble, but also facilitated the spawning of many market-specific bubbles. The bubbles in the housing, equity, and commodity markets could have been easily detected by observing the price behavior in those markets, relative to changes in the more broadly based consumer price index. True to form, the Fed officials have steadfastly denied any culpability for creating the bubbles that so spectacularly burst during the Panic of 2008-09.

If all that is not enough, Fed officials, as well as other members of the money and banking establishments in the United States and elsewhere, have embraced the idea that stronger, more heavily capitalized banks are necessary to protect taxpayers from future financial storms. This embrace, which is reflected in the Bank for International Settlements’ most recent capital requirement regime (Basel III) and related country-specific capital requirement mandates, represents yet another great monetary misjudgment (error). Indeed, in its stampede to make banks “safer,” the establishment has spawned a policy-induced doom loop. Paradoxically, banks in the Eurozone, the United Kingdom, and the United States — among others — have been weakened by the imposition of new bank regulations in the middle of a slump. New bank regulations have suppressed the money supply and economic activity, rendering banks less “safe.”