Stephen Williamson Defends the FOMC

Publication of the transcripts of the FOMC meetings in 2008 has triggered a wave of criticism of the FOMC for the decisions it took in 2008. Since the transcripts were released I have written two posts (here and here) charging that the inflation-phobia of the FOMC was a key (though not the sole) cause of the financial crisis in September 2008. Many other bloggers, Matt Yglesias, Scott Sumner, Brad Delong and Paul Krugman, just to name a few, were also sharply critical of the FOMC, though Paul Krugman at any rate seemed to think that the Fed’s inflation obsession was merely weird rather than catastrophic.

Stephen Williamson, however, has a different take on all this. In a post last week, just after the release of the transcripts, Williamson chastised Matt Yglesias for chastising Ben Bernanke and the FOMC for not reducing the Federal Funds target at the September 16 FOMC meeting, the day after Lehman went into bankruptcy. Williamson quotes this passage from Yglesias’s post.

New documents released last week by the Federal Reserve shed important new light on one of the most consequential and underdiscussed moments of recent American history: the decision to hold interest rates flat on Sept. 16, 2008. At the time, the meeting at which the decision was made was overshadowed by the ongoing presidential campaign and Lehman Brothers’ bankruptcy filing the previous day. Political reporters were focused on the campaign, economic reporters on Lehman, and since the news from the Fed was that nothing was changing, it didn’t make for much of a story. But in retrospect, it looks to have been a major policy blunder—one that was harmful on its own terms and that set a precedent for a series of later disasters.

To which Williamson responds acidly:

So, it’s like there was a fire at City Hall, and five years later a reporter for the local rag is complaining that the floor wasn’t swept while the fire was in progress.

Now, in a way, I agree with Williamson’s point here; I think it’s a mistake to overemphasize the September 16 meeting. By September 16, the damage had been done. The significance of the decision not to cut the Fed Funds target is not that the Fed might have prevented a panic that was already developing (though I don’t rule out the possibility that a strong enough statement by the FOMC might have provided enough reassurance to the markets to keep the crisis from spiraling out of control), but what the decision tells us about the mindset of the FOMC. Just read the statement that the Fed issued after its meeting.

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

What planet were they living on? “The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee.” OMG!

Williamson, however, sees it differently.

[T]he FOMC agreed to keep the fed funds rate target constant at 2%. Seems like this was pretty dim-witted of the committee, given what was going on in financial markets that very day, right? Wrong. At that point, the fed funds market target rate had become completely irrelevant.

Williamson goes on to point out that although the FOMC did not change the Fed Funds target, borrowings from the Fed increased sharply in September, so that the Fed was effectively easing its policy even though the target – a meaningless target in Williamson’s view – had not changed.

Thus, by September 16, 2008, it seems the Fed was effectively already at the zero lower bound. At that time the fed funds target was irrelevant, as there were excess reserves in the system, and the effective fed funds rate was irrelevant, as it reflected risk.

I want to make two comments on Williamson’s argument. First, the argument is certainly at odds with Bernanke’s own statement in the transcript, towards the end of the September 16 meeting, giving his own recommendation about what policy action the FOMC should take:

Overall I believe that our current funds rate setting is appropriate, and I don’t really see any reason to change…. Cutting rates would be a very big step that would send a very strong signal about our views on the economy and about our intentions going forward, and I think we should view that step as a very discrete thing rather than as a 25 basis point kind of thing. We should be very certain about that change before we undertake it because I would be concerned, for example, about the implications for the dollar, commodity prices, and the like.

So Bernanke clearly states that his view is that the current fed funds target was “appropriate.” He did not say that the fed funds rate is at the lower bound. Instead, he explains why he does not want to cut the fed funds rate, implying that he believed that cutting the rate was an option. He didn’t want to exercise that option, because he did not like the “very strong signal about our views on the economy and about our intentions going forward” that a rate cut would send. Indeed, he intimates that a rate cut of 25 basis points would be meaningless under the circumstances, suggesting an awareness, however vague, that a crisis was brewing, so that a cut in the target rate would have to be substantial to calm, rather than scare, the markets. (The next cut, three weeks later, was 50 basis points, and things only got worse.)

Second, suppose for argument’s sake, that Williamson is right and Bernanke (and almost everyone else) was wrong, that the fed funds target was meaningless. Does that mean that the Fed’s inflation obsession in 2008 is just an optical illusion with no significance — that the Fed was powerless to have done anything that would have increased expenditure and income, thereby avoiding or alleviating the crisis?

I don’t think so, and the reason is that, as I pointed out in my previous post, the dollar began appreciating rapidly in forex markets in mid-July 2009, the dollar euro exchange rate appreciating by about 12% and the trade-weighted value of the dollar appreciating by about 10% between mid-July and the week before the Lehman collapse. An appreciating that rapid was a clear sign that there was a shortage of dollar liquidity which was causing spending to drop all through the economy, as later confirmed by the sharp drop in third-quarter GDP. The dollar fell briefly in the days just before and after the Lehman collapse, then resuming its sharp ascent as the financial crisis worsened in September and October, appreciating by another 10-15%.

So even if the fed funds target was ineffectual, the Fed, along with the Treasury, still had it within their power to intervene in forex markets, selling dollars for euros and other currencies, thereby preventing the dollar from rising further in value. Unfortunately, as is clear from the transcripts, the FOMC thought that the rising dollar was a favorable development that would reduce the inflation about which it was so obsessively concerned. So the FOMC happily watched the dollar rise by 25% against other currencies between July and November as the economy tanked, because, as the September 16 statement of the FOMC so eloquently put it, “upside risks to inflation are . . . of significant concern to the Committee.” The FOMC gave us the monetary policy it wanted us to have.


12 Responses to “Stephen Williamson Defends the FOMC”

  1. 1 Lorenzo from Oz March 6, 2014 at 4:01 pm

    Scott Sumner’s point about the ultimate problem being the consensus view of mainstream macroeconomists gets some support from Williamson’s response.

    Also, if you take the view that managing expectations is central to what a Central Bank does, then the FOMC clearly failed spectacularly there because it was clearly not paying attention beyond its inflation phobia. Even the concern over the financial markets did not seem to reach as far as income expectations mattering for ability to handle debt.


  2. 2 Shahid March 7, 2014 at 2:09 am


    in my comments in response to one of your earlier posts, i had mentioned how lack of economic common sense, trained economists who’ve failed to keep up with new developments, and wrong headed economic management have hurt our economy (in Pakistan) so much. But after going through various FOMC posts (your’s and of others), i can perhaps conclude that lack of economic acumen and common sense is not specific to developing nations only. First rate economists, who’ve studied from first rate institutions, have worked in renowned institutions (like Fed), and have a reasonable reading of Econ history (Bernanke made his name through his studies on the Great Depression) are as prone to mediocrity as other, lesser qualified economists are. Setting aside inflation-phobes like Plosser, i really (and i mean REALLY) find it hard to understand why a person like Bernanke would fail to grasp the impending systemic risk? Is it too difficult to understand that fall of one organization (like Lehman) can have a substantial domino effect on the whole system? To put it simply, even a menial negative shock has the potential to disrupt the whole system through fear, panic and subsequent ‘safety first’ actions of individuals and entities.

    And my word, some of those people are still occupying decision making posts! Perhaps they are still awaiting the perceived impending doom in the form of runaway inflation, so that they can then step down with a bit of dignity about their credentials intact. Whatever happens, i can tell you that nowadays i am a very satisfied ‘third world’ resident. I can now easily argue with anybody that third world doesn’t necessarily have a monopoly on stupidity and lack of common sense. Cheers.



  3. 3 JKH March 7, 2014 at 12:06 pm

    Without looking at the data or recalling the sequence precisely, I’m wondering about the entire time line that included this meeting, the buildup of abnormal excess reserves, and the Fed’s full realization that it would eventually have to pay interest on reserves in order to prevent the effective funds rate from dropping to zero on its own momentum.

    In other words, what was going on in Bernanke’s mind at this time regarding the outlook for the Fed’s ability to control the rate to target? If they already were in the process of creating excess reserves, with downward pressure on the Fed effective rate (since no interest was being paid), it reads as if he implicitly expected some reversion back to the normal level of excess reserves and effective rate control without paying interest on excess reserves.

    Was he caught in the headlights of resisting a target rate drop because that would have reinforced the market’s perception of the Fed’s loss of operational control of the effective funds rate relative to target? With any new non-zero target, that risk would not have been eliminated, given an outsized level of non-compensated excess reserves. Perhaps an outsized target rate response that at the same time failed to regain control over the Fed effective was not a message that he wanted to send at that time?

    A question – not a thesis.

    That’s a lot to consider – operationally – at the time.


  4. 4 Benjamin Cole March 8, 2014 at 7:40 am

    Excellent blogging.
    Stephen Williamson needs to tell us what will work.He says QE cuts inflation and cutting interest rates doesn’t work either.
    Okay, central banks should do what? BTW, in Willismson’s wotld do central banks cause inflation or something else?


  5. 5 flow5 March 8, 2014 at 9:27 am

    Roc’s in MVt below roc’s in real-output always created a recession (after the Great-Depression).. The trajectory for money flows in Dec was already contractual for the 4th qtr of 2008. As a consequence, a recession was inevitable without a reversal in this trend (countervailing intervention). This is simply inviolate & sacrosanct.


  6. 6 David Glasner March 8, 2014 at 8:44 pm

    Lorenzo, I don’t get the connection between Williamson and Sumner. Are you saying that Williamson is representative of mainstream macroeconomics?

    I totally agree with your point about the FOMC mismanaging market expectations.

    Shahid, I share your astonishment at how badly Bernanke misunderstood what was going on. And if it gives you any comfort to contemplate the incompetence of our policy-makers, then by all means, take advantage.

    JKH, A lot of interesting questions to ponder. I have no answers, I am afraid. But we should be able to reader his memoirs wthin about three years, so let’s hope he will be willing to share with us what he was really thinking.

    Benjamin, More good questions. But certainly am not going to presume to speak on Williamson’s behalf.

    flow5, Forgive me, but I couldn’t understand your comment.


  7. 7 JKH March 9, 2014 at 6:17 am

    My general take also is that Bernanke should be given about 10 times the value on the asset side of his personal balance sheet for leading the Fed’s operational response to the crisis as the value he is assigned on the liability side for not having forecasted it with economy theory. I still find it amazing that a person of such intense academic background was able to give urgent leadership to an institution that required such extraordinary operational tools to deal with the crisis.


  8. 8 flow5 March 9, 2014 at 1:40 pm

    This is the Gospel and it’s literally worth trillions of economic dollars. I discovered this using bank debits in July 1979. Rates-of-change (roc’s) in monetary flows (our means-of-payment money times its transactions rate-of-turnover), equals aggregate monetary purchasing power (not nominal-gDp). Roc’s in MVt = roc’s in all transactions in Irving Fisher’s “equation of exchange. Roc’s in nominal-gDp is a proxy (snapshot), for all final product transactions.

    The distributed lags for money flows have been mathematical constants for the last 100 years. Thus economic prognostications are infallible (for less than a year). Bankrupt you Bernanke caused the Great-Recession all by himself.


  9. 9 flow5 March 9, 2014 at 1:46 pm

    POSTED: Dec 13 2007 06:55 PM |
    The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
    10/1/2007,,,,,,,-0.47,,,,,,, -0.22 * temporary bottom
    11/1/2007,,,,,,, 0.14,,,,,,, -0.18
    12/1/2007,,,,,,, 0.44,,,,,,,-0.23
    1/1/2008,,,,,,, 0.59,,,,,,, 0.06
    2/1/2008,,,,,,, 0.45,,,,,,, 0.10
    3/1/2008,,,,,,, 0.06,,,,,,, 0.04
    4/1/2008,,,,,,, 0.04,,,,,,, 0.02
    5/1/2008,,,,,,, 0.09,,,,,,, 0.04
    6/1/2008,,,,,,, 0.20,,,,,,, 0.05
    7/1/2008,,,,,,, 0.32,,,,,,, 0.10
    8/1/2008,,,,,,, 0.15,,,,,,, 0.05
    9/1/2008,,,,,,, 0.00,,,,,,, 0.13
    10/1/2008,,,,,,, -0.20,,,,,,, 0.10 * possible recession
    11/1/2008,,,,,,, -0.10,,,,,,, 0.00 * possible recession
    12/1/2008,,,,,,, 0.10,,,,,,, -0.06 * possible recession
    Trajectory as predicted:


  10. 10 flow5 March 9, 2014 at 1:49 pm

    It wasn’t the rising dollar’s exchange rate that caused the collapse. The peak in the roc in money flows (proxy for real-output) was already in place in Dec. 2007 (see 7/1/2008 = a peak in the roc of .32)


  11. 11 flow5 March 9, 2014 at 1:53 pm

    You can’t reconstruct these numbers as money flows are ex-ante, not ex-post. The science (long-run validity), is as repeatedly and accurately reproduced (predicted).

    That’s how I denigrated Nassim Taleb’s general theory of the “black swan” (the failure of circuit breakers and limits on high frequency trading) of May 6th 2010. I.e., I predicted the “flash crash” 6 months and within one day of the 1000 point swing.

    As my favorite economist Dr. Richard Anderson always emphasizes: “All analysis is a model” – Ken Arrow


  12. 12 Lorenzo from Oz March 14, 2014 at 12:09 am

    David: Not quite, but the notion that the Fed was not wrong in not “easing” was the mainstream macroeconomic view, and still is, though less so, as far as I am aware.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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