Great Recession: The Federal Reserve shouldn't brag about its response.

Commentaries on economics and technology.
April 26 2011 3:59 PM

Proud of What?

Why the Federal Reserve and other central banks shouldn't brag about their response to the Great Recession.

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The world's top independent financial minds have looked long and hard at these arrangements, and, given what we have learned in recent years, have found them worse than wanting (for details, see the research of Anat Admati at Stanford's Graduate School of Business). In their view, the big banks should be funded much more with equity—perhaps as much as 30 percent of their capitalization. But bankers strongly reject this approach (because it would likely lower their pay), as do central bankers (because they are too much persuaded by the protestation of bankers).

There are many advantages to having an independent central bank run by professionals who can keep their distance from politicians. But when the people at the apex of these institutions insist that the crisis response went well, and that everything will be fine, even as the financial behemoths that caused the crisis lumber forward, their credibility inevitably suffers. That should worry central bankers, because their credibility is pretty much all they have. The Constitution, after all, does not guarantee the Fed's independence. Congress created the Fed, which means that Congress can un-create it. By assuming away the damage that highly leveraged megabanks can do, the myth of a "good crisis" merely makes political pressure on central banks all the more likely.

This article comes from Project Syndicate.

Correction, April 27, 2011: This article originally misspelled the last name of former Citigroup Chairman Sandy Weill. (Return to corrected sentence.)

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Simon Johnson is a professor at MIT’s Sloan School of Management and the co-author of White House Burning: The Founding Fathers, Our National Debt, And Why It Matters To You.