Everything that needs to be said has already been said.
But since no one was listening, everything must be said again.

Andre Gide

Thursday, March 4, 2010

Will Federal Reserve Secrecy Conceal Incompetence and Corruption?

Having your own blog can be lot's of fun. I especially enjoy the spirited debates with some of my readers (from whom I have already learned a lot from).

I had a recent exchange with "Pointbite" where I challenged the sanity of Ron (Conspiracy Theory) Paul. The debate, however, was strangely aborted. I thought that Pointbite had given up. I realize now that there must have been a technical glitch that prevented him/her from posting a response. Happily (for me, at least), I accidently came across Pointbite's rebuttal here.

I think that Pointbite asks some good questions. I'm planning another post on the subject. But for now, let me briefly try to clear a few things up.

First, I am not saying that the Fed should never be audited. And I am not saying that the Fed should keep all things secret forever. What I am suggesting is that there are some types of information that should not be disclosed during a financial crisis. The identity of those banks making use of the discount window or emergency lending facilities is an example of such information that should probably not be disclosed; at least, not until the crisis has passed. Likewise, the terms of the lending arrangements should not be disclosed; again, until well after the crisis is passed.

The rationale for such a policy, whether it ultimately proves correct or not, is at least a plausible one for now. Releasing such information during a crisis is likely to lead to a run on the banks involved; exacerbating the crisis. Moreover, because of the stigma associated with using the window, disclosure of such information would prevent banks from participating. The rationale for encouraging participation, of course, assumes that it is socially desirable. This is debatable, for sure. But it is precisely this that should be debated. Gratuitous attacks on the Fed, like those served by Ron Paul, are absolutely of no help here (although he will find them useful for political reasons).

Some other things of note. The Fed has evidently never released information relating to its discount window lending. On routine lending as the normal term is very short (typically overnight, to healthy institutions, fully secured), I fail to see any purpose from disclosure at any time but if the lag were long enough, no real harm either -- just the burden/cost of publicly disclosing something that no one will much care about.

The Section 13(3) special facilities is a different matter from routine discount window lending. This section has not been used for such a long time that I don't think the Fed has any clear policy concerning the release of information here (except that it shall not be released during a financial crisis). I believe that such information should eventually be released, and Bernanke has evidently suggested as much in his testimony to Congress.


  1. David:

    Economists distinguish themselves from many other secular priests and lay people by calling for the allocation of economic property rights and the design of institutions where private incentives and social goals coincide as best as possible. Always with the involvement and blessing of the state.

    Assuming that economists actually "get it", this is the area where economists excel at making social contributions in areas as diverse as monetary policy and fisheries management. No matter how poorly the policy contributions of economists are understood.

    Economists shun heavy-handed regulation and micro-managing from centralized bureaucracies. Everybody else expects the state to solve problems despite glaring evidence of the potential problems with kind of approach, for example, the massive overbuild in light-trucks and SUVs since the late 1990s.

    Most people expect substantive information to be contributed at meetings that become part of the public record. They do not understand that much critical information exchange occurs prior to meetings out of the public spot light.

    Economists tend to emphasize how people wiggle around regulations and accountability. Others view avoidance behaviour as immoral and unethical, and stay focused on the minutiae of process rather than results.

    Just sayin'. Have no clear ideas what to do about this. Correct me if I am wrong, but even if the US central bank has yet to formally adopt inflation targeting policy, it has adopted many of the trappings of an inflation targeting regime which emphasize communicating policy and policy changes as clearly and early as possible.

    The only developed-country central banker who strikes me as disposed to surprising his constituents with policy changes is Stanley Fischer, governor of the Bank of Israel. Israel's situation is somewhat unique; much power is concentrated in the hands of the BOI governor. Fischer may be a little more traditional activist-Keynesian in philosophy than many North American economists too. That said, from what I understand, the BOI appears to be doing a good job. (Some dual-listed Israeli companies look attractive.)

  2. It is the overall lack of transparency that makes the Federal Reserve look extremely bad. We don’t know how or why the Fed makes decisions. And the Fed’s decisions cause transfers of wealth across agents. (Imagine locking in a short term contract at one rate, and then having the Fed raise/lower rates on you; this is a transfer of wealth across agents).

    It’s not clear to me that unelected officials should have the ability to transfer wealth across agents. But that aside. If the Fed just stated what it knew (i.e. Green book) and why it was doing what it was doing (FOMC minutes and discussion), then ex-post, we could have looked back and said we did everything the best we could with the information we had.

    But we don’t have that now. We have secret bailouts of AIG and Bear Stearns – billions of dollars of transfers from one set of taxpayers to another – with no oversight and no transparency.

    This is why people have reason to be outraged at the Fed’s behavior.

    Two more things:

    1. This secrecy creates cults – and perpetuates the myth that the Fed can have a big long-term impact on economic variables. Don't forget Greenspan allowed a book called "Maestro" to be written about him. Why? Because he didn't raise rates in 1995? As if the Federal Reserve can take or deserves any claim at all for the productivity boom of the late 1990s.

    2. When the minutes from the May 2010 special meeting at the FOMC on house prices become public, ALL HELL will let loose. If those minutes had just been public at the time, people would have understood the nature of the debate etc.

  3. that should read May 2005 special meeting.

  4. modavis99: The US federal reserve is much more transparent than just a few decades ago. Bernanke is a big fan of transparency in setting bank policy.

    A formal inflation targeting regime might help improve outcomes because it will help the central bank focus on price stability and the value of the US dollar.

  5. Hi David, just confirming I have seen this post. I don't know why I wasn't able to post my last comment, but apparently everything is working again. I'm looking forward to your next post on this topic.

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  7. Mo,

    You make several good points. But perhaps you are a little off the mark too.

    What do you mean that we don't know how or why "the Fed" makes decisions. This is probably not even clear to the members of the FOMC!

    And as for your statement that you are not sure whether unelected officials should be granted the power of wealth transfer, this reminds me of the person who remarked, in response to the problem taxation without representation, with the response "taxation with representation ain't so hot either!"

    And my interpretation is that people express rage at the Fed because the Fed is a convenient political target; it has little to do with "transparency" or the lack thereof.

  8. David, I think you need to make a better argument from an economics point of view for withholding information by the Fed. In theory information can be "bad" if there is some weird strategic interaction involved or if there's no commitment. Why is the possibility of a bank run a good example - wasn't deposit insurance created for that purpose - why have FDIC if it will never be used? Just wondering, you know I am not a monetary guy.

  9. David I found your paper that I believe will address my comment above. I'll read it and will let you know if my opinion changed. Thanks.