The View From 1776

The Fed’s Policy Blinders And Blunders

The Federal Reserve attempts more than it can accomplish or should attempt, but neglects what should be its primary duty: maintaining a sound dollar.

Read Robert P. Murphy’s Fed Policy and Asset Prices


O’Driscoll has here put his finger on a major inconsistency in the Fed’s official line. Up until Bernanke’s recent reconsideration, the Fed has denied that its job was to worry about asset bubbles. Alan Greenspan declared that it was impossible for the Fed to recognize an asset bubble in real time (whereas his successor, Bernanke, had always been less sure about the subject).

Yet here’s the contradiction: In addition to not wanting to interfere with markets by popping asset bubbles, Greenspan also had his famous policy of the “Greenspan put.” In other words, Greenspan viewed it as the Fed’s job to intervene with loose money when asset prices crashed, but not to implement tight money when asset prices soared.


The so-called Greenspan put led the Fed to flood the financial system with excess fiat money after the 1987 stock market crash and after the boom-bust in the 1990s, which segued into the housing price bubble and the 2008 collapse of financial institutions. 

As Professor Murphy notes, one of the Fed’s earliest policy actions after its 1913 creation was doubling the entire banking system’s lendable reserves in about six years during the 1920s, with the intention of keeping prices up to their World War I inflated levels.  The theoretical justification was prevention of the sort of short-term recession that historically occurs when a nation shifts from wartime full-employment production to peacetime activities.  The result, instead, was stock market speculation, speculatively booming real estate prices, and increases in consumer debt via installment financing, newly supported by banks flush with lendable funds courtesy of the Fed.  The 1929 stock market crash and the Great Depressions were just around the corner.

Today, the Fed’s several injections of excess fiat money into the financial system are benefitting almost exclusively the financial institutions.  The stock market is booming (unsoundly speculatively, I believe) and banks are coining money playing the spread between near zero cost of funds and relatively risk-free returns on Treasury securities.

Meanwhile, you and I (especially those of us living on a fixed income) are the ones really paying for this excrescence of Keynesian inflation by receiving much-reduced returns on our investments while struggling with rising costs of living.