Ex-BOE Exec Scored Excessive Fed Rate Cuts

Excessive cuts to interest rates will further fuel higher inflation rates.  This was asserted by a former Bank of England executive, adding that this decision of the US Federal Reserve as a response to financial crisis was a terrible mistake.

Dressing-down the Fed

Willem Buiter, a professor at the London School of Economics, presented a harshly critical paper during the annual monetary conference of the Federal Reserve in Jackson Hole, Wyoming.  Professor Buiter dressed down the Fed stressing that it made a strategic blunder in judging the effects of the general slow down of the US housing market.

Buiter said that the Fed went too far, too fast, and over-reacted to the crisis emphasizing that the extreme cuts to official policy rates could bring negative impressions that the Fed is not really serious in curbing inflation.  

Buiter further argued that using official policy rate for resolving problems of liquidity and solvency has been proven ineffective.

Defaults Led to Fed Cuts

The global crunch on financial assets was a direct impact of increasing defaults on housing mortgage payments in the US and the resulting drop in the value of house prices in the US housing market.  The resulting crisis led Fed officials to cut interest rate benchmark to 2% from a high of 5.25% last summer.  The Fed protected this rate cut during its past two policy meetings.

Buiter is generally in agreement with the Fed that price instability of assets cannot be resolved by implementing official monetary policies.  The professor however asserted that regulatory policies would be more effective rather than using federal funds rate as instrument.  By not regulating the investment banks as they plunged into riskier investments and fiscal markets, Buiter holds the Fed partially responsible for the mess created by the crash of the housing market.

Cleaning Up After the Bubble Burst

Professor Buiter criticized the approach of finance authorities to ‘clean up the mess created by the bursting investment bubble.’ The Bank of England did not escape the criticism of Professor Buiter saying that current bank executives are guilty of doing too much.  He praises them however for keeping the current interest rates and not succumbing to pressures to lower the rates.

According to Buiter, central banks have been used as the state’s quasi-fiscal agents through the extension of subsidies to banks and other financial institutions.  The effect, Buiter argues, is increasing inflationary pressures which are already becoming evident on latest economic data.

Fed’s Tarnished Reputation

US inflation jumped to 5.6% in July which was the highest in its history.  Professor Buiter said this event tarnished the reputation of the Fed to keep prices stable.

Professor Buiter also asserted that central banks erred in estimating the role of declining prices in the whole economy.  The productivity of financial businesses has been questioned by Buiter saying that they are profitable only for private interest but essentially wasteful for society.