Dr. Peter Diamond has once again found himself in the cross-hairs of Sen. Richard Shelby of Alabama, the highest ranking Republican serving on the Senate Banking Committee. A Nobel laureate and MIT professor, Diamond has been nominated three times for the vacant seat on the influential Federal Reserve Board, twice having been blocked by Republicans at the committee stage for approval to the full Senate.
At the nomination hearing this past Tuesday, Sen. Shelby provided a critical analysis of Diamond’s economic philosophy.
“In short, Dr. Diamond is an old-fashioned, big government Keynesian. Many of us believe that this is not the economic philosophy the Fed should be embracing at this point in our economic history. Our economy is already suffering from excessive government debt and misguided regulation. Our financial regulators should be trying to take steps to strengthen our markets, rather than replace them with new layers of government.”
Shelby noted Diamond’s support of the President’s $800 billion stimulus package and his call for additional fiscal stimulus. He also referenced a paper written by Diamond and former CBO Director Peter Orszag that argued for higher taxes. “The policy preferences of Fed nominees matter,” Shelby observed.
Sen. Pat Toomey of Pennsylvania, a former bond trader and veteran of the financial services community, is no fan of the Fed’s monetary policy, which he feels is over accommodating. He raised some serious concerns about the likelihood of rising inflation and the result that would have on the Fed’s forthcoming exit strategy from its monetary policy.
“The obvious response from the market to rising inflation expectations is higher interest rates, higher bond yields. In the face therefore of higher bond yields, I fear that the Fed could find itself in a situation where it also has to exit by selling bonds, and I worry that the process of exit would lead to much higher interest rates from the combination of these phenomena.”
Diamond provided a rather general response (a common feature of these proceedings) highlighting the range of instruments available to the Fed:
“The Fed has multiple tools. The interest paid on excess reserves can play a critical role in adjusting the way the exit strategy is executed so that we don’t get a rapid burst of lending and inflation. I think the combination of tools available will permit a smooth exit.”
QE2, an unconventional and extremely risky tool, was not just a response by the Fed to a sluggish economy; it was a testament to the President’s failed stimulus policies. How the Fed will handle its monetary gamble will require great vigilance and good fortune. By judiciously examining his economic philosophy, Republican Senators are keen in determining how Diamond will influence the Fed’s role in future financial crises.
Note: The views expressed in this article are the author’s and do not reflect the position of the Heritage Foundation.