The Fed’s Industrial Policy

I’ve seen lots written in the past year on the Federal Reserve Bank’s (Fed’s) expansion of the monetary base, but almost nothing written about changes in the Fed’s policy to target its funds and support toward specific institutions. Prior to Bernanke’s reign as Chairman, the Fed acted in a way that was neutral toward specific firms. That has changed, as the Fed has targeted particular firms to benefit from its support, mimicking the industrial policy that Japan has practiced for decades.

Prior to Bernanke, the Fed made loans to banks that were members of the Federal Reserve system through the discount window. Member banks that were financially sound but that had short-term liquidity problems could get loans. Under Bernanke’s tenure, Fed lending was extended to firms that not only were not member banks, but that were not even commercial banks. This is a major change in Fed policy.

Prior to Bernanke, the Fed controlled the size of the money supply and interest rates by engaging in open market operations, which is the buying and selling of Treasury securities. The Fed bought government-issued debt, which affected interest rates, the money supply, and ultimately inflation, but in a manner that was neutral toward participants in the economy. Under Bernanke the Fed has targeted securities issued by specific firms, some clearly in the private sector and some government enterprises. It owns securities issued by Fannie Mae and Freddie Mac, and securities issued by other firms too.

I’d like to tell you exactly whose securities the Fed has bought, but I don’t know and the Fed’s not telling. Bloomberg news has sued the Fed under the Freedom of Information Act to try to find out, but the Fed says it doesn’t have to disclose the information, and it would be harmful to do so.

The clearest case of the Fed targeting and supporting a particular firm was its $80 billion bailout of AIG in 2008.

These actions represent a substantial change in the policy orientation of the Fed. Rather than being a neutral overseer of the nation’s money supply the Fed is engaging in industrial policy, targeting some firms for support while letting others fend for themselves. The biggest contrast if the bailout of AIG versus the collapse of Lehman Brothers.

The precedent is a bad one. Market forces should determine which firms thrive and which struggle, not government oversight or Fed policy. Back in the 1980s Japanese industrial policy was widely praised by many in the U.S. because of Japan’s phenomenal growth rate. After the Japanese economy stagnated in the early 1990s enthusiasm for industrial policy waned. Now the Fed is engaging in the same type of policy.

The Fed has a huge responsibility — and huge power — because it controls the nation’s money supply. We are better off with a Fed that focuses solely on that rather than one that expands its power into other areas, regardless of those other areas. But industrial policy is counterproductive in any event, so it is especially troubling to see Fed policy headed this way.