Where Fed's critics got it wrong in GOP debate

Commentary

The Federal Reserve was instrumental in easing the impact of the Great Recession. As bad as the downturn was, it could have have been worse if central bankers hadn't aggressively used monetary policy to curb the severity of the crisis and help put the U.S. economy on the path to recovery.

So it has been disappointing to hear Republican presidential candidates bash the Fed in their debates and on the campaign trail. For example, the Fed's low interest rate policy is blamed for causing income inequality -- except that the gap between rich and poor started to widen decades ago in the 1970s.

The argument doesn't hold up even if it is limited to the time period the Fed's policy has been in effect. The gains in employment and resulting growth in income from low interest rates and quantitative easing, a Fed bond-buying program aimed at stimulating economic growth, more than offset other factors. Would inequality be lower, on average, if the unemployment rate were 8 percent instead of 5 percent and if millions more were unemployed?

Yes, the Fed could have pursued policies that did more to help middle-income households. For instance, more could have been done to help people hurt by the housing bubble (the Fed helped banks that were hurt, after all, so why not households too?). Still, the Fed is not responsible for income inequality. The source of that problem lies elsewhere.

The Fed is also accused of playing politics by keeping interest rates low. But that shows a lack of understanding of how the Fed conducts monetary policy -- indeed, the criticism makes no sense. Republicans criticize the Fed because its low interest rate policy supposedly hurts the economy, yet somehow the central bank is keeping interest rates low to help the economy? I am not impressed with that argument.

For now, the Fed is keeping interest rates low because that's what economic conditions demand. Inflation is below target, labor markets are doing better but still have plenty of slack, and both of those factors call for low interest rates. Interest rate hikes would make the problem worse, not better. Raising rates too soon and delaying the recovery is a much harder mistake to recover from than waiting too long and experiencing inflation. In other words, it's much easier to bring inflation down than it is to bring employment up.

So the Fed is right to be patient, and it will raise rates when the economy is ready, not when it makes politicians of either party happy.

And don't get me started on the proposals to return to a gold standard. That shows nothing but, well, ignorance. That idea has been thoroughly debunked -- it simply doesn't deliver the benefits that are claimed, while the problems are much larger than acknowledged. To be charitable, perhaps the call to return to a gold standard can be explained by Republican politicians pandering to populist beliefs about the Fed and money. But it's not so clear that charity is called for. It's a truly bad idea.

As Ben Bernanke recently made clear , the Fed's policy of an extended period of low interest rates is a consequence of the failure of Congress to do its job. Instead of pursuing expansionary fiscal policy over and above the initial stimulus package once it was clear more stimulus was needed, or simply holding the line, Republicans in Congress pursued austerity. And they did so aggressively with threats of government shutdowns and so on.

Additional stimulus from fiscal policy would have put upward pressure on interest rates, and the Fed could have begun normalizing monetary policy much sooner. Instead, congressional Republicans did the opposite. They pushed for austerity policies that helped to push interest rates down. Democrats went along, eventually, and that was a mistake, but Republicans drove the policy. There was no way that additional stimulus would make it to President Obama's desk; austerity prevailed, making it much harder for the Fed and hampering the economic recovery. There was no way the Fed could raise rates in such an environment.

So it's a bit irksome to hear Republicans, many of whom are in Congress, spouting on about the Fed's poor policy when they are the ones who endorsed a policy mistake in pursuit of political and ideological objectives. The Fed did what it needed to do. Republican lawmakers didn't.

Although some Republicans want Congress to have control over the Fed, the bank's independence was a critical factor in its ability to pursue sound policies and avoid the politics that lead to gridlock, or the mistakes that were made with fiscal policy. The next time you hear Republicans call for more control and oversight of the Fed by Congress, think about how poorly Congress did with fiscal policy, and how creative and aggressive the Fed became in trying to compensate for that failure. Then ask yourself whether that is a good idea.