Monetary Policy at a Crossroads

Special Guests: Thomas Hoenig

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This week on Facing the Future, we looked at the interaction of fiscal and monetary policy with Dr. Thomas Hoenig, former President of the Federal Reserve Bank of Kansas City and a member of the Federal Reserve System’s Open Market Committee (FOMC) from 1991 to 2011. He is now a Distinguished Senior Fellow at the Mercatus Center. Concord Coalition policy director Tori Gorman and chief economist Steve Robinson joined the conversation.

Following the Great Recession of 2008-09, Dr. Hoenig was the only member of the FOMC to vote against the Fed’s decision to purchase large amounts of Treasury securities and mortgage-backed securities – a policy known as quantitative easing. He dissented at all of the FOMC meetings in 2010. We asked him about that and about the Fed’s more aggressive use of quantitative easing in response to the COVID-19 pandemic. Finally, we got his take on the implications that Fed actions have for our nation’s long-term economic and budgetary challenges.

Hoenig told us, “I did not object to the massive liquidity injections into the economy in 2008, or even part of 2009, because we had this terrible crisis, and the Fed was created to help provide liquidity into the economy during a crisis. But quantitative easing was truly begun in 2010 and the economy had already started to improve in the third quarter of 2009. So you had the economy improving and that’s when the Federal Reserve should say, ‘all right, we’re going to step back now. We’re not going to tighten down. But we’re going to stop easing. We’re going to stop a crisis policy so that the economy can rebalance so that the liquidity that we provided can be used, and then we go from there.’ ”

Hoenig said he also “understood completely” the Fed’s broad injections of liquidity into the system in March 2020 as the COVID-19 pandemic rocked the economy. “As broadly or not, we can discuss that – but the fact of the matter is, I would have agreed with that.”

In Hoenig’s view, however, quantitative easing in response to the pandemic went on too long. “The recovery had already begun, believe it or not, in August of 2020. All right, so you let it go a little longer to make sure. But this emergency policy of injecting enormous amounts of new money into the system went on not only in 2020, but through 2021 and the first quarter of 2022, which enormously increased asset values, and by that time actually worked into the general prices of goods and services. That’s when you’re distorting your economy and undermining the long run potential growth and the distribution of wealth within that economic system. And that’s what I think is wrong.”

One economic distortion Hoenig is particularly concerned about is the tendency of quantitative easing to reallocate wealth in favor of asset holders.

“Increasing money by massive amounts, and keeping the interest rate at zero introduces a greater likelihood of a misallocation of resources,” Hoenig said. By putting interest rates to zero and having all this money available you cause asset values to increase enormously. It also can increase the stock market and, as we found, with that kind of excess in the market, asset values went up substantially. That had the effect, at a minimum, of increasing wealth in a new way. If you held assets, you became relatively wealthier than those who were wage earners – who did not have new homes and didn’t have a big stake in the stock market. And so you create greater differences in the wealth distribution in the economy.” 

Over time, Hoenig warned, quantitative easing creates winners and losers, encourages non-productive speculation in the economy and harms the middle and lower middle. “You can see the harm just in terms of the social reaction to all this after the great financial crisis. You have these protests all over the country. You have this unsettled social environment we’ve had ever since,” he said.

Another concern we discussed with Hoenig is how the Fed will react to the nation’s growing debt. “So in today’s world,” he commented “that’s one of the debates going on: is there fiscal dominance over the Federal Reserve policy? In other words, is the debt so large and so important going forward that the Fed has to accommodate it by buying government debt and keeping interest rates low? I think it’s a huge issue. The Federal Reserve was set up to be independent to keep the government from issuing too much debt and allowing it to say, ‘no, we’re not going to buy your debt. We’re not going to print the money to buy your debt any longer,’ and that puts a discipline on the government.”

“We used to have a gold standard. We don’t have that anymore,” Hoenig observed. “All you have now is this Federal Open Market Committee who has to act independently as if they were the gold standard, and when they fail to do that then we invite future inflation. And that’s the drama going on, I think, inside the Federal Open Market Committee today as it deals with monetary policy.”

“If the Federal Reserve says no to the printing of money, interest rates will rise, and put more pressure on Congress to reduce spending or increase taxes. So it has a big role to play, and if it is not independent it will cave and print money, and we will eventually reignite inflation in this country,” Hoenig warned.

In his view, short-term thinking and lack of shared sacrifice are major hurdles for both fiscal and monetary policy.  He urged leaders in Congress and the executive branch to agree that: “Yes, we have an issue. Yes, we need to take care of it. And yes, we have to have shared sacrifice. So we’re going to look at all expenditures. We’re going to look at all taxes. And we’re going to get this thing brought into control.”

“Only when we make those hard choices as a nation and our leadership takes us that way will we begin to address this problem systematically and for the long term. Otherwise, eventually we will print more money. I can assure you we will have more inflation, because the only way you reduce the relative size of the government debt is to devalue the debt by inflation. And we undermine our social fabric, because it will have winners and losers big time – and conflict,” he concluded.

Hear more on Facing the Future. I host the program each week on WKXL in Concord N.H., and it is also available via podcast. Join us as we discuss issues relating to national fiscal policy with budget experts, industry leaders, and elected officials. Past broadcasts are available here. You can subscribe to the podcast on Spotify, Pandora, iTunes, Google Podcasts, Stitcher, or with an RSS feed. Follow Facing the Future on Facebook, and watch videos from past episodes on The Concord Coalition YouTube channel.

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