The Ethics of the U.S. Monetary Policy in Response to the Financial Crisis

0:00As the title of my paper suggests, my paper is a moral analysis of the Federal Reserve's policy since the crisis began in August 2007, although a more acute phase started in September 2008. Needless to say, there's been a lot of analysis of the Fed's actions over the last year and a half, but much of it has revolved around the question whether or not the Fed will actually succeed whether or not its policies will work in reviving the economy. Very little, except perhaps implicitly, but very little has been said about the ethics, the moral dimensions of monetary policy.

0:49And indeed, this is nothing new, as Guido Huelsman, I hope I'm pronouncing that correctly, Hulsman, as he mentioned in his recent work on the ethics of money production at the beginning, he surveys the moral discussion of monetary policy and finds that there's very little unless you go way back to the late scholastics. So this is nothing new. Monetary policy for various reasons has become a part, something that a technical clique This elite is viewed as having some special knowledge because of their knowledge of mathematics and models and their jobs to manipulate various aggregates, M1, M2, GDP, CPI and no one else really can talk about the ethics of what they're doing because they know what's going on.

1:51So my paper is designed to fill this gap, this absence of a moral dimension to the discussion of monetary policy. Now anytime you start talking about morality, you start running into the question, who's to say what is moral? That is a question I always hear from undergraduate students every time I teach a class in ethics. And beneath that question, of course, is this skepticism, relativism even, that says that unlike questions of natural science or mathematics where objective truth seems to be generated, ethics is a place where it's just a matter of opinion and that's it.

2:39And there's really not much more we can do about it except to clarify our respective of Opinions and perhaps tolerate each other. Behind this skepticism or relativism, whatever you want to call it, ultimately it's rooted in the idea that there is no agreement among moral philosophers. In the natural sciences, in math, they seem to produce agreement, therefore we feel confident in referring to their conclusions as objective truths, but in moral philosophy, because you You've got people who are utilitarian, some are Kantians, some are Sotelians, and all the rest, all the other perspectives. People conclude that there's no objectivity there. So to deal with this problem here in evaluating monetary policy, I propose that we select four major moral theories that are diversified in the sense that they have varying perspectives on what counts as a moral action and see if they can produce agreement.

3:48If they can produce agreement, then while we may not have the objectivity of Einstein's theories or Newton's theories, we can at least reach a point on the continuum where we're making statements where there's arguably at least compelling to a neutral observer. So that's my approach in the paper. I pick four moral theories, apply them to US monetary policy. If there is unanimity or a strong majority in favor of a particular view, I conclude then that with some reasonable assurance that our conclusions are binding on neutral observers. Now the four moral philosophies that I choose are Aristotle's Virtue Theory, Locke's Natural Cultural Rights Philosophy, Kant's deontological vision of morality, and utilitarianism.

4:45And on utilitarianism, because there's many varieties of utilitarianism, I decided to just go with Jeremy Bentham's view A, because his view on the subjectivity of happiness, because he argues that happiness is really just a positive balance of pleasure over pain, and pleasure is whatever the person thinks it is, and same with pain, and there's no There's no objective way to evaluate pleasure and pain, which John Stuart Mill, another utilitarian actually argued for. So I decided to go with Bentham, also because Bentham's views actually are ensconced within the economics profession, or at least the orthodox understandings of economics. So those are the four theories. They're very different in the sense that some emphasize duty, some emphasize rights, some Some emphasize happiness, guiding one's actions by the good, others emphasize the notion of guiding one's actions by moral principle, by the right.

5:46Some focus on the individual, some focus on society. So my thinking is that if we can get unanimity out of this sample of four theories, each with very different fundamental starting points, different assumptions about human nature and and the Nature of Morality, then maybe we've got a sound basis upon which to evaluate the Bernanke Fed's actions. Now, in my paper, I summarize Bernanke's monetary policy. I do so on the basis of various speeches he's given over the last year. He's done a number of them and usually he repeats the same analysis. He usually organizes the Fed's actions into three different prongs, if you will.

6:34One is that they lowered rates, we all know about that, if I remember it started at 5.25% before the whole thing started and progressively came down and now we're down practically at zero. It's really the most dramatic lowering of rates in the history of the Fed. The second prong of the Fed's monetary policy response to the crisis has been the provision of liquidity. Here the Fed has been following the playbook set out by Walter Badgett in Lombard Street, a 19th century book. And in that book, Badgett argued that if you have a crisis, you're just supposed to throw liquidity into the system so that people have an assurance that if they need it, they can get money.

7:20Assurance, then they'll be less likely to seek liquidity. And there have been various measures here. They've extended the discount window in terms of the amount of time that they provide loans to institutions. They've accepted a wide variety of securities. They've taken action to support the commercial paper market, the money market funds. So that's the second prong. And then the The third prong, harder to categorize, the best way of putting it is that here the Fed is trying to deal with the systemic issues, the overall structure of the financial system and in this part of the policy response, the Fed, for example, guaranteed $29 billion of securities that Bear Stearns had on its balance sheet to facilitate the takeover of its takeover, by Barry Stern's Takeover by J.P. Morgan. You got the AIG money here, which now I think goes up to 150 billion last week. They got another injection. And they've also sought to support the mortgage security market, trying to get mortgage rates down, buying Fannie Mae

8:36and Freddie Mac mortgages. And there's talk, but my understanding that it hasn't become The Federal Reserve, fiat money, fractional reserve banking, Human Action, Man Economy and State, The Theory of Money and Credit

9:41PowerPoint, but I wanted to show you an image of, it's not even a hockey stick, the way Al Gore shows the famous hockey stick, it's essentially vertical, the monetary based move and most of that since the fall of 2008. Now so far it really hasn't percolated into the system, M2 is starting to percolate a bit, M2 is a broader definition of money supply, includes checking deposits and savings deposits, And the reason why it hasn't flowed into the financial system as of yet is because commercial banks are very nervous about their capital asset ratios, so they're very wary of lending. Also, there isn't a lot of loan demand out there.

10:26It's not like many people are actually going in and asking for money. People are generally retrenching. So but if once the economy does revive and one hope it does and banks start using some of this money on reserve and we go from 110 or 120% reserve system, whatever we have now to the more normal situation, then this whole thing is the money will, the money supply will could literally explode. I mean, given the move in the monetary base, the implications for the broader aggregates of money are actually quite scary. Now, the Fed assures us, i.e. Ben Bernanke assures us that they'll mop up this liquidity as soon as the signs emerge that the economy is doing better.

11:19But I would argue that it's unlikely that they'll do so. Politically, it'll be very difficult for them to do so because once the economy starts Reviving and they take money out of the system, they're going to get complaints from Congress and Wall Street that they're nipping or recovering the bud. Their record of doing so isn't good. In 2001, 2002, they were making the same sort of argument that we're going to take money out of the system, but they didn't, at least not quickly enough, and that led to the real estate boom. And then there's also the point, too, that Peter Bernholz makes in his book on inflation on monetary regimes, which he points out that all inflation is ultimately rooted in huge huge budget deficits which political officials feel compelled to monetize and of course we're looking at, given the budget projections of the current Obama administration, we're looking at huge deficits, percentage of GDP, something we haven't seen since World War II.

12:12So given that we're looking at inflation, that's the assumption I work with in applying the Four Moral Theories. Let me quickly go through the application of the Four Theories. Aristotle argued that morality is best evaluated by looking at the virtues. Morality is about cultivating a good character, developing certain virtues. There are many virtues that Aristotle talks about in the Nicomachean Ethics, but two are especially germane. One is liberality, which has to do with the giving and receiving of money. Basically, Aristotle had sort of Aristotle has two definitions of justice, commutative and distributive. Commutative has to do with reciprocity in transactions.

13:17If you add money to the system, what will happen is that it doesn't all come in at once. The people who get the money first have an advantage in transactions because they'll be able to use the money at prices that don't fully reflect the inflation and they'll get the better in transactions. So the inflation will create a lack of reciprocity in transactions. Not to mention that inflation will cause redistribution of income and wealth. People who are on fixed incomes who have most of their assets in paper will lose out to those who have money and hard assets or who have ways of indexing their income. So this redistribution takes place without any reference to merit, which violates Aristotle's theory. Locke, this one's a fairly simple one to apply.

14:05Locke was a proponent of property rights. I won't go into the full story of how he backs that up, although it actually has a lot to do with the invention of money, and clearly inflation undermines our property rights insofar as the government is taking part of our wealth away. With Kant, Immanuel Kant, his theory of morality is based on the categorical imperative. This has two parts. One part is, before you do anything, conceive whether it could be universalized, i.e. made into a universal rule, and could it still be logical in making it universal.

14:52And I would argue no with inflation. If you were to universalize the rule, which the Fed is applying here, whenever there's a crisis, whenever there's economic difficulties, we're going to pump up the money supply dramatically. I would argue that that's logically contradictory because in doing so, you're effectively undermining the meaning of money. Money has a significance because the government artificially restricts its scarcity, but once you universalize this rule that the government, whenever it feels that there's a crisis, then you're undermining money no longer is something with a command over goods and services, but now becomes something that just a piece of paper. Finally, utilitarianism, this I would argue is really what the Fed is operating under though they're not fully conscious of it.

15:37They're worried about deflation and I won't go into the full story about how they see why they're so concerned about deflation. They would argue ultimately that deflation will lead into this sort of vicious spiral where prices go down, layoffs occur, prices go down further. I point out that by adding money to the system, you are avoiding the economy from doing the and Necessary Restructuring. I would also argue that you're probably going to make the economy much more cyclical, much more volatile, because at some point the Fed is going to have to come in. And finally, deflation, historically speaking, is not as bad as people think, so that's basically my paper.