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John Cochrane thinks the world's most important central bank has lost its way and should get back to basics

Public Policy / opinion
John Cochrane thinks the world's most important central bank has lost its way and should get back to basics
US Fed floor logo

The nomination of new members to the US Federal Reserve Board offers an opportunity for Americans – and Congress – to reflect on the world’s most important central bank and where it is going.

The obvious question to ask first is how the Fed blew its main mandate, which is to ensure price stability. That the Fed was totally surprised by today’s inflation indicates a fundamental failure. Surely, some institutional soul searching is called for.

Yet, while interest-rate policies get headlines, the Fed is now most consequential as a financial regulator. Another big question, then, is whether it will use its awesome power to advance climate or social policies. For example, it could deny credit to fossil-fuel companies, demand that banks lend only to companies with certified net-zero emissions plans, or steer credit to favoured alternatives. It also could decide that it will start regulating explicitly in the name of equality or racial justice, by telling banks where and to whom to lend, whom to hire and fire, and so forth.

But before considering where the Fed’s regulation will or should go, we first need to account for the Fed’s grand failure. In 2008, the US government made a consequential decision: Financial institutions could continue to get the money they use to make risky investments largely by selling run-prone short-term debt, but a new army of regulators would judge the riskiness of the institutions’ assets. The hope was that regulators would not miss any more subprime-mortgage-size elephants on banks’ balance sheets. Yet in the ensuing decade of detailed regulation and regular scenario-based “stress tests,” the Fed’s regulatory army did not once consider, “What if there is a pandemic?”

When a pandemic did arrive in early 2020, the Fed repudiated the “never again” promises of 2008, this time intervening on an even larger scale. That March, the dealer banks proved unable to intermediate the market for plain-vanilla US Treasury securities. So, the Fed propped up the market. Critics had long pointed to problems with the Fed’s liquidity rules, and fixing these markets would have been simple, but obvious reforms had languished. Later, there was a run on money market funds. The Fed bailed out money market funds once again. There is nothing simpler to fix than money-market runs, but the fix never happened.

The Fed also funded new municipal-bond issues and propped up corporate bond prices, essentially offering a whatever-it-takes guarantee. In 2008, the Fed and the Department of the Treasury had balked at the idea of raising the market price of all mortgages under the Troubled Assets Relief Program. Yet in 2020, the “Powell put” had established an explicit floor for corporate bond prices – and more.

The predictable rejoinder to this critique will be: So what? The COVID-19 lockdowns might well have triggered a financial crisis. The flood of bailouts worked, so much so that our problem today is inflation. We do not need to worry about systemic risk, because the Fed and the Treasury will just put out any new fires with oceans of new money.

The problem, of course, is the incentives these policies have created. Why bother keeping cash or balance-sheet space to buy on the dip, provide liquidity, or treat a “fire sale” as a “buying opportunity?” The Fed will just front-run you and take away the profit. If you are a company, why issue stock when you can just borrow, knowing that the government will prop up your debt or bail you out, as it did for the airlines? If you are an investor, why hesitate to buy shaky debt, knowing that its value will be guaranteed by another “whatever-it-takes” commitment from the Fed in bad times?

No wonder America is awash in debt. Everyone assumes that taxpayers will take on losses in the next downturn. Student loans, government pensions, and mortgages have piled up, all waiting their turn for Uncle Sam’s bailout. But each crisis requires larger and larger transfusions. Bond investors eventually will refuse to hand over more wealth for bailouts, and people will not want to hold trillions in newly printed cash. When the bailout that everyone expects fails to materialize, we will wake up in a town on fire – and the firehouse has burned down.

In 2008, regulators and legislators at least had the sense to recognize moral hazard, and to worry that investors gain in good times while taxpayers cover losses in bad times. But the 2020 blowout has been greeted only with self-congratulation.

The same Fed that missed the subprime-mortgage risks in 2008, the pandemic in 2020, and that now wishes to stress-test “climate risks,” will surely miss the next war, pandemic, sovereign default, or other major disruptive event. Fed regulators aren’t even asking the latter questions. And while they issue word salads about “interconnections,” “strategic interactions,” “network effects,” and “credit cycles,” they still have not defined what “systemic” risk even is, other than a catch-all term to grant regulators all-encompassing power.

Regulators will never be able to foresee risks, artfully calibrate financial institutions’ assets, or ensure that immense debts can always be paid. We need to reverse the basic premise of a financial system in which the government always guarantees mountains of debt in bad times, and we need to do it before the firehouse is put to the test.

Better regulation can bridge partisan divides. The left is correct that big banks are inefficient oligopolies that serve most Americans poorly. But it has the cause wrong. An immense regulatory compliance burden is a major barrier to market entry.

Calls for “more” regulation are meaningless. Regulations are either smart or dumb, effective or ineffective, full of undesired consequences or well designed. We need better regulation. We need more capital, not many more thousands of pages of rules. Capital provides a buffer against all shocks, and it does not require regulators to be clairvoyant. The Fed has scandalously blocked narrow-banking enterprises and payments providers that could help serve many Americans’ financial needs.

Before turning to healing the planet and righting injustice, the Fed should be held to account for how badly it is doing on the basic task of protecting the financial system.

John H. Cochrane is a senior fellow at the Hoover Institution, a conservative think tank based at Stanford University in California. Copyright: Project Syndicate, 2022, published here with permission.

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I don't know about the FED, but our RBNZ has lost all my respect. Watching an unelected entity promote inequality was something I never thought possible in our society. It is truly us and them in NZ and now I know that this is the case, my whole mindset to our system has changed. I am sure I am not the only one.


Did you even contemplate the RBNZ much before this? Their mandate has nothing to do with equality.


Oh yes, because the RBNZ only does things it is mandated to do?

Under his (Orr's) leadership, the bank has developed a Tāne Mahuta story using the Māori god of the forest to explain how it fits in the financial system, is embedding Māori language and culture throughout the organisation, is working to deepen its understanding of the Māori economy, and is rebranding to better reflect its identity and purpose.…


That is actually part of an initiative that strongly encourages all public sector organisations to incorporate Te Reo and consideration for Maori cultural norms into their practises and naming:

The Public Service (formerly State Services) Commission (PSC) has a leadership role in the state sector. It gave evidence during the te reo Māori claim about the public service and the lack of opportunity for Māori-speaking citizens to interact with government agencies in their preferred language. The WAI11 recommendations included a substantial number aimed at improving the status of te reo Māori in the state sector. Some were implemented. The PSC now has a role in ensuring that the modern state sector implements the Maihi Karauna, the Crown’s Māori language strategy.

Not to mention there's a significant difference between a branding exercise and trying to resolve inequality. 

Quite clearly, asset inflation is exacerbating the divide between the haves and have nots, but the RBNZs central mandates centre more on handling inflation (which they currently don't have a handle on) and encouraging full employment. Either way, the worse off are living hand to mouth, so in light of the pandemic, the options for the RBNZ were to let nature take its course and have the subsequent job losses effect that community, or let the money rain and have those people's net worths lag behind people with assets. 

But I suppose you have a pitchfork and need to aim it somewhere.


The RBNZ has shown a total disregard for Maori and Pacific Islanders who have been most seriously disadvantaged by the RBNZ's repulsive monetary policies. This proves any rebranding was purely superficial gaslighting. If the RBNZ were not just a vessel to protect the rich then they would have achieved their primary mandate of keeping the CPI inflation outcomes between one percent and three percent. Mandates don't seem to matter to Adrian Orr, house prices do.


The RBNZ is going outside its mandate to brownwash to Maori!

Wait, pivot, the RBNZ is persecuting Maori!

Virus make economy go boo-boo, fancy man in office try to make decision in lose-lose bad time, ok.


I agree 100%. Orr and his RBNZ cronies are just full of s..t. They could not care less about Maori and Pacific Islanders. They could not care less about inequalities. They could not care less about their primary mandate of keeping inflation under control. They could not care less about financial instability created by their reckless, stupid, unbalanced ultra-loose monetary policy, whole highly damaging effects will create big structural problems in the NZ economy for the years to come. They could not care less about the financial instability created by the explosion of debt and by the completely unbalanced NZ economy, where parasitic unproductive housing speculation has been incentivized, at the expense of the real economy. They could not care less about the new generations.

Even now, rather than acknowledging their massive policy mistakes and urgently raising the OCR to 3% now, they are moving way too slowly, which will force them to ultimately raise the OCR to much higher level (close to 4%, I think) later on, once inflation starts really getting out of control. 


I will never forget attending an RBNZ/ TSY public webinar in mid-2020 discussing the Bank’s planned QE expansion and large-scale asset purchase program, which it was about to roll out. I asked the obvious question of whether the Bank considered the program would intensify mortgage lending and the housing crisis as QE had done all over the West (and indeed, was designed to do). Should the Bank not consider putting strings on the lending arising from the program? No, no, and no, were the answers. Approaching two years on, house prices have risen a further 40%. While this can not properly be attributed entirely to the Bank’s program, the program almost certainly amounted to pouring petrol on the fire.


Spot on here. More regs are a dead weight to the instant reality of boom & bust. At least boom & bust is self-regulatory, but we just don't seem to be brave enough to cope with the bust. Bust is essential if boom is to take place. Bust clears out the cowboys (& cowgirls) & resets automatically without the need for our somewhat limited political class to engineer a better result - which they can't & they won't. All they will do is weigh it down. Leave it to the markets to sort itself out. Okay, some will get hurt on the way through, but that's how some people learn. And if you don't learn you'll never grow. And if you never grow then we end up with socialism. Just like we have now!


The writing is on the wall, the longer this inaction continues the worse it will be. Combating inflation already looks too hard. I don't know much but from what I understand, if the fed hikes rates NZ must follow or else our currency devalues which feeds higher inflation in NZ by raising the nominal value of our exports (more attractive to sell overseas) and raises the cost in NZD to import. Again it just forces the RBNZ to hike by a different measure. 

The question I have is around debt. How does any central bank commit to hiking given the extraordinary debt levels? 5.3b in consumer credit excluding mortgages in NZ. 

Or does this just mean rates won't have to rise as much to cool inflation? In which case as I previously mentioned what happens to little old New Zealand if we get caught trying to keep up with US rate hikes despite a recession in NZ? Wouldn't that just destroy our currency and economy?


Yes, RBNZ will get more "bang for buck" from ocr rises due to the amount of debt. That's why interest rates are unlikely to go back to historical highs.

Once they get inflation back on track here they will stop hiking. It might take a recession to stop inflation though.


Okay, granted that is the case and say here in NZ we settle down with an OCR of 3%. What then happens if the US hikes to 4%? 

Given that we are the smaller economy more at risk of default or some other such issue, we must offer something in return for people holding our debt. I just can't see a situation where we can have a lower OCR than the reserve currency. In which case would the reserve bank not be forced to match the US and then some to ensure our currency retains it's value? If so would this not hurt NZ greatly?

The key assumption here is that our OCR must be higher than that of the US. Is this the case? 


Between 2018-2020 our OCR was lower than the Fed, so it's definitely possible.

An interesting question about the relative risk between economies, but I think the answer lies in what the ocr is, i.e it isn't a rate we borrow offshore at, it's the rate of on settlement accounts the commercial banks hold at RBNZ.

There could well be a divergence with other wholesale funding sources.


Thanks for pointing that out, I wasn't aware. 

Since that's the case, the chances of interest rates fixing the housing market are nill. The RBNZ shouldn't end up in a position where it becomes collateral damage. A bit disappointing tbh, but oh well.


The OCR will affect interest rates and the housing market but it is only one factor.


Shouda listened to Peter Schiff, George Gammon and a bunch of other podcasters. They’re been warning about this Fed clusterf## for several years. 

And the same could be said about a number of commenters with respect to the fake NZ rock star economy based on a ponzi housing market.


100% Agree with the headline : Why isn't the Fed doing its job?

Fed has totally lost the plot along with other reserve banks like RBNZ who has been imitating Fed.

Questions are being raised after the damage has been done, should have been vigilant earlier when all data suggested that reserve bank has been going overboard with their policy of least regret and even today as are forced to retrace are playing with time being forced to act.

It was evident since early 2021 that inflation was getting out of control,  touching new high every month but as were in denial mode went out of the way to silence the voices being raised on high inflation by coining Transitory Inflation. Finally in December were forced to admit to take U turn that their is no such thing as transitory inflation, which is getting out of control as never seen before but still did they acted to raise the OCR if the situation is so bad, No,  they just mentioned it and will actually act after four months in March. Someone should ask them, why March when the situation is dire and need urgent attention just like March of 2020 when OCR was dropped immediately without any delaying tactics.


I completely agree. The OCR must be raised steeply and with extreme urgency, and it should go to at least 3% as soon as possible. Not doing so will force the RBNZ to raise it to higher levels later on. The longer the RBNZ waits to carry out the necessary actions, the higher interest rates will have to go later on.  

The RBNZ's puppets are in complete denial mode, and the NZ economy will pay a dear price for their incompetence and ineptitude. It is time to sack Orr and get somebody in charge who has the ability to make the necessary hard calls, NOW. 

Actually, it might be already too late. Maybe we really need to have a big bust in the NZ housing markets, so that things start getting back in balance. Hopefully, this will not be the case, but time is fast running out before the opportunity of a managed correction is overtaken by the likelihood of a disorderly correction driven by market fundamentals.