Fed Speak Hard To Decipher

The role that the Federal Reserve played in the 2008 financial crisis continues to be hotly debated. Last week, former Fed Chairman Alan Greenspan said the central bank wasn't in a position to police the housing market. But in a recent interview with NPR, the chairman of the New York Fed said something slightly different — and in the typically close-mouthed world of the Fed, slightly different can mean a lot.

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ROBERT SIEGEL, host:

The Federal Reserve has announced a major shift in policy.

MICHELE NORRIS, host:

Or rather, a high level Fed official has made a proposal that suggests it might be time to begin considering a shift in some aspects of Fed policy.

SIEGEL: As you can hear, it's hard to report on Fed news. News often refers to big things that happen all of a sudden. But the Fed makes changes incredibly slowly, gradually and after tremendous consideration.

NPR's Adam Davidson of our Planet Money team has this report on a policy proposal that could transform our economy - maybe.

ADAM DAVIDSON: The biggest news in this radio story might be that the story exists at all. By longstanding tradition, the Federal Reserve Bank of New York, the most powerful regional Fed bank in the country, does not do interviews for broadcast.

The next biggest news is that in this broadcast interview, William Dudley, president of the New York Fed, breaks with another tradition: He publicly criticizes past Fed officials. He does it politely, using Fed-speak, but make no mistake, these are fighting words.

Mr. WILLIAM DUDLEY (President, Federal Reserve Bank, New York): You know, obviously hindsight is 20/20. But it seems to me, with the benefit of hindsight, it seems like things could have been done to restrain the asset price movements in a way that would have generated a more stable financial system and a more stable macro economy.

DAVIDSON: Man, can you believe he said that? That is just nasty. Seriously, that was probably the most mild, polite smackdown possible. But what he's saying is, hey, Alan Greenspan, you messed up. And not just you, pal, every Fed chairman in the 97 years of Fed history.

The details are a bit technical. Sorry, folks, it is the Fed, after all. The Fed's job is to prevent inflation or deflation on the stuff that's called consumer goods and services: food, cars, doctors' visits. The Fed has not tried to influence prices on the stuff that's called assets, things you buy for investments: stocks, bonds, real estate. The Fed view is: Consumer prices, our job, asset prices, not our job.

Here's Greenspan last week.

Dr. ALAN GREENSPAN (Former Chairman, U.S. Federal Reserve): Regulators cannot calibrate regulation and supervision in response to movements in asset prices.

DAVIDSON: Take that, Dudley. Dudley's response is to point out that the financial crisis we're in now came about because of rapidly rising asset prices - the price of homes - not because of consumer price inflation. So if the Fed is going to keep our economy stable, it should pay attention to asset prices. And sure, Greenspan, we won't be perfect at it.

Mr. DUDLEY: My view is it's not so much that we're going to prevent all asset bubbles. I think that's unrealistic. But what we might be able to do is prevent the asset bubbles from being quite so big, and maybe from preventing the consequences of the asset bubbles from when they burst being quite so bad.

DAVIDSON: Dudley isn't even saying he knows exactly what to do or how to do it. He is so much more mild than that.

Mr. DUDLEY: What I'm proposing is that we try. Try to identify bubbles in real time. Try to develop tools to address those bubbles. Try to use those tools when appropriate to limit the size of those bubbles, and therefore try to limit the damage when those bubbles burst.

DAVIDSON: And you don't know if you can pull it off.

Mr. DUDLEY: No. I mean, you know, but until you try, you know, you're certainly not going to succeed if you don't try.

DAVIDSON: I'm going to assume that most people in the U.S. would respond to this by saying, of course the Fed should try to identify asset bubbles, of course they should try to make them less damaging. I'm guessing most people would be furious to learn that the Fed wasn't even trying to keep an eye out for a housing bubble.

Allan Meltzer, prominent Fed historian, says despite what Dudley is telling you: Don't hold your breath.

Professor ALLAN MELTZER (Political Economy, Carnegie Mellon University): They won't do it. I mean, they may talk about it but they won't do it.

DAVIDSON: Meltzer says there's a very simple reason: Asset bubbles, by definition, mean prices are rising so fast that the only way for the Fed to stop them would be to raise interest rates so high that it would throw the economy into recession. He says the Fed isn't stupid - they've faced booming asset prices a bunch of times, and every time they argued: with asset bubbles, the cure is worse than the disease.

Prof. MELTZER: That was the argument in 1929. It was the argument in 1968 and the 1990s.

DAVIDSON: New York Fed President Dudley says he begs to differ: We're living through the disease right now and he wishes we had tried to cure.

Adam Davidson, NPR News.

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