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The Fed has no clothes?

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Larry Downing/Reuters

(Read caption) Chairman of the Federal Reserve Ben Bernanke speaks in Washington, Jan. 18. Guest blogger Jerry O’Driscoll writes that Charles Plosser recently criticized Fed policy at a speech in Chile.

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Philadelphia Fed President Charles Plosser gave a major speech on Monday at the Central Bank of Chile. In the polite language of central bankers, the speech constitutes a systematic criticism of not only current Fed policy but of the Fed’s entire response to the financial crisis.

Plosser’s speech updates Milton Friedman’s 1967 presidential speech to the AEA and quotes from it. “…We are in danger of assigning to monetary policy a larger role than it can perform, in danger of asking it to accomplish tasks that it cannot achieve, and, as a result, in danger of preventing it from making the contribution that it is capable of making.”

In Friedman and Plosser’s analysis, the sole contribution monetary policy can make is price stability. What, in the current context, can monetary policy not achieve? Plosser enumerates impossible goals of monetary policy.

  • Short-run stabilization of the real economy is “beyond the scope of monetary policy.”
  • Attempts at short-run stabilization are likely to provide stimulus when not needed and vice versa.
  • Stabilization policies “risk distorting price signals and thus resource allocation, adding to instability.”
  • “…Monetary policy cannot reverse the sharp decline in house prices when the economy has significantly over-invested in housing.”

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