Humans, not metrics, need to run the Fed

It’s an irony of modern life. We are awash in metrics, but the most important things are difficult or impossible to measure.

Economics, which is an important thing, is no exception to this iron law. That’s why we need people instead of algorithms heading up the Federal Reserve.

We might think that monetary policy would be one of the exceptions to the rule. Money has been around for a long time and unlike the economy, it doesn’t change much from year to year. It does change, of course, but its basic structure remains very similar as years pass. We can understand the wisdom of some of Alexander Hamilton’s decisions, for example, because the savings and investment forces in the financial market t 0hen are much the same today.

Still, because the economy and financial markets are always changing and responding to each other’s changes, leading the Federal Reserve is like steering an unfamiliar ship in hazardous situations. Sometimes a gentle touch on the rudder works best; other situations only a decisive move will get the ship to respond appropriately.

Sometimes, what’s needed is something different entirely. At one point during the Great Recession, for example, the Federal Reserve found itself in a pickle. Its most reliable tool to stimulate the economy, lowered interest rates, seemed to have exhausted its effectiveness. The interest rate was already zero or even negative and yet the economy was unresponsive.

With the familiar, traditional tools ineffective, the Federal Reserve decided that it needed something different, something new and untried. It launched something it called “Quantitative Easing,” or “QE” for short.

What QE involved was the Fed’s purchase of the long-term Treasury bonds and, especially, the Collateralized Mortgage Obligations (CMOs) that were clogging up the commercial banking system. The market for these CMOs had essentially dried up and the banks were stuck with them on their books, crippling their lending capability. The economy, which depends on commercial loans for its growth, was also stuck in a near-dormant state.

In the belief that QE would clean up commercial banks’ balance sheets, improve their liquidity and encourage them to expand commercial lending, the Fed began purchasing the securities.

The program at first didn’t seem to have any effect. That left the question of whether to abandon the idea or not. The Fed was playing in a high stakes game, and had already risked $800 billion to no avail.

It took a lot of moxie to double down on an expensive program that showed little results. Considering what the atmosphere at the Fed must have been brings to mind a much-used classic scene in the old movies in which the beautiful nurse wipes the perspiration from the brow of the handsome surgeon under pressure to “do something.” The Fed’s experience and bankers’ instinct, though, told them to expand the program. They poured what eventually totaled another $2.5 trillion into what became known as QE2 with, again not much to show for it.

Much later, QE3 was the last effort to jump-start the economy. It was different in that it consisted of regular, announced purchases of securities, $40 billion per month at the beginning, and $80 billion per month by the time the program ended.

By the time Quantitative Easing ended, The Federal Reserve’s balance sheet had ballooned to $4.5 trillion. But it never provided the spark the economy needed. Subsequent analysis would show some improvement in the employment picture from QE3, but the real worth of the program — and the fundamental economic policy idea behind it — is in the changes it produced in the noggins of commercial bankers and their corporate borrowers.

In a sense, the value of Quantitative Easing is not so much what happened as a result but what didn’t happen. Most of America did not get locked into Depression-like thinking and eventually investors realized that our financial structure was still standing and operating normally. The economy gradually turned around and ever so gradually began to recover.

The economy clearly needed a booster shot but the economists’ tool box was virtually empty. We had weathered the storm but the calm that followed was draining our mojo.

The sharp economic acceleration that coincided with the campaign and election of President Donald Trump was as big a surprise to economists as the financial crash had been eight years earlier. It was a reminder that economies are driven both by known and unknown forces and sometimes do surprising things.

There are distinguished economists and a few politicians that want to replace the Fed’s leadership with some simple equations. But when a new situation requires innovation and resourcefulness, we want a human being at the helm. We are, in that sense, irreplaceable.

James McCusker is a Bothell economist, educator and consultant.