And we are live at Project Syndicate once more:
Broadly speaking, for possibly longer and for at least 115 years--since the publication of Swedish economist Knut Wicksell's Geldzins and Guterpreis--economists have divided into two camps with respect to what a central bank like the Federal Reserve system really is. One camp, call it the Banking Camp, sees a central bank as a bank for bankers: its clients are the banks; it is a place where banks can go to borrow money when they really need to; and its functions are to support the banking sector so that banks can make their proper profits as they go about their proper business and, especially, to ensure that there is enough credit and liquidity in the economy that mere illiquidity rather than insolvency does not force banks into bankruptcy and liquidation. Another camp, call it the Macroeconomic Camp, sees a central bank as an institution to make it so that Say's Law--the principle that production is balanced by demand, with their neither being too little demand to purchase the goods and services produced and so cause unemployment nor too much and so cause unexpected inflation--holds in practice, because it is surely true that Say's Law does not hold in theory. It sees the central bank as the steward of the economy as a whole, with its primary responsibility not to preserve the health of the businesses that make up the banking sector but rather to maintain the health of the economy as a whole.
In the United States, from September 15, 2008--the day that the investment bank of Lehman Brothers filed for bankruptcy--until then-U.S. Treasury Secretary Tim Geithner announced on May 8, 2009 that in his judgment the major U.S. money-center banks had or could quickly and easily raise adequate capital cushions, the interests and conclusions of the two camps were identical: reducing the imbalance between aggregate supply and aggregate demand required, first and most important, preserving the banking system; preserving the banking system required boosting aggregate demand so that the gap between it and aggregate supply lessened. There was a lot of economic stimulus in bank rescue, and there was a lot of bank rescue in economic stimulus.
Thereafter, not. A prolonged and sustained central-bank policy of keeping short-term Treasury nominal interest rates low is essential to keep the many interest rate-sensitive components of aggregate demand from falling even further below potential aggregate supply. But such a policy makes life very difficult for commercial, investment, and shadow banks, especially commercial banks with expensive networks of branches and ATMS, to report regular and healthy operating profits on their quarterly income statements and to report regular gains on their clients' portfolios. A prolonged and sustained central-bank policy of purchasing ever-increasing quantities of long-term assets is essential to get a financial sector with diminished appetite for risk to use some of its risk-bearing capacity for its proper purpose of reducing the risk burden on entrepreneurship and enterprise. But such a policy removes diminishes financiers' ability to rely on the easy business of riding the duration yield curve for profits. A simple and straightforward central-bank statement that in the aftermath of 2008-2013 it is clear that inflation targets in the 0-2%/year range run unwarranted downside employment risks, and that inflation targets should instead by in the 2-4%/year range is an obvious no-brainer from the standpoint of an organization that exists to balance aggregate demand to potential aggregate supply. But such an announcement would make all bankers who hold nominal assets or who think in nominal terms physically ill.
I believe it is very important for the public interest of the U.S. and the world that President Obama appoint. a Federal Reserve Chair from the Macroeconomic Camp. The U.S. and the world today needs one at least as much as they did four years ago.