Just Vote NO

On Tuesday, July 21, the Senate Banking Committee will vote on whether to support Dr. Judy Shelton’s nomination to join the Board of Governors of the Federal Reserve System. Accordingly, we are re-posting our July 2019 commentary in which we outlined our strong opposition to Dr. Shelton’s candidacy.

In our view, over the past year, the case against Dr. Shelton has strengthened. The Federal Reserve’s speedy and decisive response to the COVID pandemic is a key reason that the U.S. financial system has steadied and the economy quickly began to recover from the worst shock since the 1930s. Had the United States been operating on a gold standard, as Dr. Shelton has long advocated, these Fed actions would not have been feasible.

Indeed, under a gold standard, instead of easing forcefully and committing to sustained accommodation, the central bank would have been obliged to tighten policy in an effort to resist the 19-percent rise of the gold price since the end of 2019. Just as it did in the Great Depression, this policy would have led us down a path of financial crisis and economic disaster (see our earlier posts here and here).

We hope that the Senate Banking Committee will vote down Dr. Shelton’s candidacy and send a determined message that unambiguously backs the Federal Reserve’s commitment to use every means at its disposal―zero interest rates, large-scale asset purchases, and broad lending programs―to restore economic prosperity and maintain price stability. Barring outright rejection, the Committee should at least move to hold an additional hearing on this nomination, as the Committee minority has proposed….

Protecting the Federal Reserve

Last week, President Trump tweeted his intention to nominate Dr. Judy Shelton to the Board of Governors of the Federal Reserve System. In our view, Dr. Shelton fails to meet the criteria that we previously articulated for membership on the Board. We hope that the Senate will block her nomination.

Our opposition arises from four observations. First, Dr. Shelton’s approach to monetary policy appears to be partisan and opportunistic, posing a threat to Fed independence. Second, for many years, Dr. Shelton argued for replacing the Federal Reserve’s inflation-targeting regime with a gold standard, along with a global fixed-exchange rate regime. In our view, this too would seriously undermine the welfare of nearly all Americans. Third, should Dr. Shelton become a member of the Board, there is a chance that she could become its Chair following Chairman Powell’s term: making her Chair would seriously undermine Fed independence. Finally, Dr. Shelton has proposed eliminating the Fed’s key tool (in a world of abundant reserves) for controlling interest rates—the payment of interest on reserves….

Ensuring Stress Tests Remain Effective

Last month, the Federal Reserve Board published proposed refinements to its annual Comprehensive Capital Analysis and Review (CCAR) exercise—the supervisory stress test that evaluates the capital adequacy of the largest U.S. banks (34 in the 2017 test). In our view, the Federal Reserve has an effective framework for carrying out these all-important stress tests. Having started in 2011, the Fed is now embarking on only the seventh CCAR exercise. That means that everyone is still learning how to best structure and execute the tests. The December proposals are clearly in this spirit.

With this same goal in mind, we make the following proposals for enhancing the stress tests and preserving their effectiveness:

--- Change the scenarios more aggressively and unexpectedly, continuing to disclose them only after banks’ exposures are fixed.
--- Introduce an experimental scenario (that will not be used in “grading” the bank’s relative performance or capital plans) to assess the implications of events outside of historical experience and to probe for weaknesses in the system.
--- As a way to evaluate banks’ internal models, require publication of loss rates or risk-weighted assets for the same hypothetical portfolios for which the Fed is disclosing its estimates.
--- Stick with the annual CCAR cycle....

Why a gold standard is a very bad idea

The extraordinary monetary easing engineered by central banks in the aftermath of the 2007-09 financial crisis has fueled criticism of discretionary policy that has taken two forms. The first calls for the Federal Reserve to develop a policy rule and to assess policy relative to a specified reference rule. The second aims for a return to the gold standard (see here and here) to promote price and financial stability. We wrote about policy rules recently. In this post, we explain why a restoration of the gold standard is a profoundly bad idea.

Let’s start with the key conceptual issues. In his 2012 lecture Origins and Mission of the Federal Reserve, then-Federal Reserve Board Chair Ben Bernanke identifies four fundamental problems with the gold standard:...

Commentary

Money, Banking, and Financial Markets