CFE Analysis

Closing the Fire Station, to Motivate Less Smoking in Bed

In the spring of 2009, amid the darkest moments of the Great Recession, I published a book and a blogpost. The book, reviewed here, championed the notion that mainstream macroeconomic thinking failed to appreciate, for good and ill, the central role that finance plays in capitalist economies. The blogpost, co-authored with then CFE colleague Jon Faust, drilled down on the inescapable need to rescue financial markets amid major swoons—lest they amplify recessionary forces and precipitate debt/deflation/depressions.

Where do these matters stand, close to a dozen years later? Mainstream macroeconomics no longer denies, but in practice continues to severely downplay, the central role of finance, in the creation of destabilizing excesses. Witness near universal hysteria with the Fed for tightening, 2018, given low inflation, and oblivious to the mushrooming expansion of corporate debt that was building momentum over the period. When COVID-19 collapsed the world’s economy, the U.S. Federal Reserve, and central banks around the globe, spectacularly came to the rescue, thwarting any financial market/real economy adverse feedback loop—to almost an embarrassing degree.

In short, mainstream macroeconomists continue to willfully ignore the issue of building destabilizing excesses in financial markets. Almost all agree, however, that collapsing asset markets justify aggressive central bank rescue.

On the Fed rescue front, in the aftermath of the Great Recession, a part of the Dodd-Frank legislation required that Fed buying of corporate and municipal securities—permittable until then given the Exigent Circumstances clause, 13.3, would require U.S. Treasury permission. In March of 2020, amid the panic in financial markets, Congress enacted legislation providing funds for a Treasury/Fed rescue effort. Which brings us to Senator Toomey’s demands that the three $500 billion Treasury financed facilities end, as originally planned, 12/31/2020.

Do I agree that central banks have been quick to rescue swoons, but oblivious to market excesses? It was the essential point of my book of 2009, and as 2020 comes to a close, it looks all the truer. But tying the central banks hands, in an effort to let the markets fully punish bad finance? That’s akin to removing airbags from steering columns, and replacing them with butchers’ knives—drive safer, for you surely will die in a crash.

What about the risks that the Fed, with funds to finance corporate endeavors, can weigh in such matters as supporting renewables financing versus fossil fuel energy company bonds? Clearly that is a fiscal policy issue. If the elected officials of this nation choose to support one industry over another, fiscal policy can be enacted, and if the central bank is used as an instrument of that policy, so be it. But no such legislation exists today. And as such, it is fanciful to think that the Fed would unilaterally choose to go down that rabbit hole.

In sum, on the other side of the COVID-19 crisis—which the gift of vaccines makes a real likelihood by this time next year—much remains to be sorted out about the interplay between monetary and fiscal policy, saddled with the zero bound and contemplating the existential threat of climate change. Thankfully, as reported tonight, we seem to have stopped just short of closing down the Fire Station, as a means to get us to be more careful smokers. Praise be.