Federal Reserve Now Admits its Models Don't Work

Sankarshan Acharya
Founder, Pro-Prosperity.Com and Citizens for Development

May 24, 2014

The U.S. central bank (Federal Reserve Board) has now publicly admitted that its econometric models for forecasting inflation, unemployment and economic depression do not work.[1]  Data generated by a fundamentally unfair (unconstitutional), unstable and inefficient system of money and finance cannot consistently help frame monetary policy to rectify the inherent weakness in the system: this truth was discovered in my 2007 research, “Constitutional System of Money and Finance,” now published in the Journal of Financial Transformation. That the JFT which invited me to submit this paper has 18 Nobel Prize winners as authors and prominent professors from universities like U of Chicago and U Penn as editors substantiates the fait accompli that the central banking model of monetary policy has badly failed.[2] This paper indeed proves that the current system of money and finance is unconstitutional, economically inefficient and unstable.  It also presents an alternative model which is constitutional, economically efficient and stable.  In addition, this paper demonstrates how the current econometric model of the Federal Reserve Board has failed to forecast inflation and onset of depression and how the alternative model offered in it is paramount to the economy.

The admission by the Fed is obviously important for the world because of the following reasons:

  1. Central banks worldwide use the same kinds of models as the Federal Reserve does to forecast inflation, unemployment and economic depression.
  2. The central banks worldwide have failed to foresee the catastrophic financial shock of 2008 when the markets in the advanced economies crashed.  The U.S. Congressional Financial Crisis Inquiry Commission found in its report released in January 2011 that the financial catastrophe was manmade (avoidable) and that it was due to failure of the Federal Reserve and established academic experts.  The US Congress indeed adopted the same policies – safe central banking and minimum capital requirement for bank holding companies on a consolidated basis – as those obtained in my research and submitted to it since 2003 to avert the crisis preemptively.[3,4,5] The U.S. government had to guarantee $11.3 trillion of previously uninsured bank debt and money market funds to stem the domino of crashing markets due to unprecedented panics and runs.  
  3. The Federal Reserve has been printing trillions of dollars since 2008 without being able to improve the US economy structurally.  The Federal Reserve chairperson has publicly outlined two disturbing economic trends beyond Fed’s control: growing long-term employment and rising inequality.[6]   
  4. Massive amounts of virtually created dollars through a practically useless monetary policy adopted by the most powerful central bank are being gathered as hard reserves of central banks and as retirement savings of Americans as well as citizens worldwide in lieu of their real service and output and as values of their real assets.

Ultimate Power Center:  The U.S. Board of Governors of the Federal Reserve System (known as ‘Federal Reserve’ or ‘Fed’) was created by the Federal Reserve Act of 1913.  The FRA was basically foisted on Americans through vote within a powerless Congress by 13 ‘Robber Barons’ who emerged as the most powerful individuals to control the financial and political system in USA in the aftermath of the excruciating banking panics and runs that they had caused in 1907.  The banking panics and runs had so enervated the Americans that the surviving Robber Barons and their creditors panicked about their amassed credits being written off by the indebted majority of those robbed.  To protect their credits and sway over America, the Robber Barons preemptively scripted the FRA to empower the Federal Reserve to print new money (on the back of the people being robbed) to repay only their creditors should their borrowers default, i.e., refuse to remain financially enslaved.  The 13 banks formed a Clearing House LLC that controls markets and dictates every economic policy in USA via the Federal Reserve.  The CH membership has grown to 23 as of 2008.  CH members comprise the Federal Reserve safety net.  Soon after the financial crisis of 2008, the Deutsche Bank withdrew from of this safety net.

Only the CH members could take over small banks that fail during a crisis by a tacit policy agreement between the Federal Reserve and Federal Deposit Insurance Corporation.  This policy gave enormous power to CH members to orchestrate periodic crises to cherry pick the good assets of any non-CH bank with additional taxpayer funds given for the rescue, by completely zeroing out all stakeholders of smaller banks thus taken over.  CH members have thus grown enormously larger and powerful after every crisis including the Great Recession of 2008, which was worse than even the Great Depression according to Fed, because it involved panics and runs over 11.3 trillion of uninsured money market funds and bank debts. 

True Freedom of People:  The enormous power of the Clearing House LLC (remote controller of global political leaders) is now rapidly disintegrating.  This is enormously beneficial to the real U.S. and global economies.  This has been possible due to pure curiosity in 1987 of yours truly about the periodic economic crashes in USA.  This curiosity led to a rule to foreclose banks optimally (optimal from the point of view of taxpayers) based on their capital levels dropping below a minimum threshold.[7] 

The bank foreclosure rule was promptly adopted by the U.S. Congress in a new act called the Federal Deposit Insurance Corporation Improvement Act of 1991.  Stability of the U.S. banking system wrought by optimal bank foreclosure led to quadrupling the U.S. economy thereafter.  The bank foreclosure rule was unprecedented in the history because even the representatives of people (members of U.S. Congress) did not have the power to foreclose banks, while the latter could foreclose indebted households and businesses before FDICIA-1991 was passed. 

The Federal Reserve ‘invited’ me with a special package to serve as a financial economist to advice on framing of rules under the FDICIA-1991 that emerged from my research.  While at the Fed, I found that the Fed and the CH members were in league to run a system of moral hazard to control/blackmail every intellectual and political leader that ever emerges anywhere to even talk about changing their system. The ‘invite’ by the Fed might have been designed to stifle my subsequent research.  The design went haywire because I would not succumb to moral hazard.[8] I developed a general equilibrium micro-economic model of the economy to obtain macro policies (the first such paper ever written in the literature) for efficient resolution of moral hazard in governance of banks and financial markets and mimeographed it at the Fed in 1991,[9] despite credible threats and advices to not pursue such research.

Top Fed officials had questioned me if I could econometrically test for existence of moral hazard in banking and financial markets.  Such tests needed private trading book data of the CH members that even the Fed could not easily have.  The 2008 financial catastrophe, however, bared the entire scheme of moral hazard in governance of banks and financial markets.  Even the Federal Reserve has now publicly admitted that moral hazard is serious (April 28, 2014).[10] The Federal Reserve and U.S. government have initiated credible steps to tame moral hazard. 

The world needs to probe the failure of the existing monetary policy models seriously to tame potential inflation and to achieve sustainable economic development.

With best regards,
SankarshanAcharya     
Founder, Citizens for Development and Pro-Prosperity.Com

[1]Miller, Rich (Apr 25, 2014 9:32 AM CT), “Yellen Concerned Fed Model Fails to Predict Price Moves,” Bloomberg News, http://www.bloomberg.com/news/2014-04-25/yellen-concerned-fed-model-fails-to-predict-price-moves.html 

I have also submitted a memo to you on the Federal Reserve ultimately admitting that moral hazard has seriously affected the economy, as found in my research.  This memo is available at http://pro-prosperity.com/Federal%20Reserve%20Now%20Admits%20that%20Moral%20Hazard%20in%20Banking%20and%20Finance%20is%20a%20Serious%20Problem.html

[6]“Two economic trends that Janet Yellen says are very disturbing,” http://money.cnn.com/2014/05/08/investing/yellen-inequality-unemployment/
[7]Acharya, S. and J.F. Dreyfus (1989), “Optimal Bank Reorganization Policies and the Pricing of Federal Deposit Insurance,” Journal of Finance, http://pro-prosperity.com/Research/Bank-foreclosure-rule-paper-Acharya-Dreyfus-Journal-of-Finance-1989.pdf
[9]The latest version of this model is available here http://pro-prosperity.com/Research/moralhazardliberty.pdf