Economics, Monetary Policy, Pethokoukis

Don’t end the Fed, mend it — just not the way most GOPers want to

Image Credit: Medill DC (Flickr) (CC BY 2.0)

Image Credit: Medill DC (Flickr) (CC BY 2.0)

Townhall’s Kevin Glass gives the nickel tour of AEI’s panel from last Friday, “Mend it, don’t end it: Revamping the Fed for the 21st Century.” One reason I held the panel, as Kevin points out, is to try and shift center-right views on the Bernanke Fed (make it more like the hawkish ECB!) and monetary policy. From my intro:

Many on the right – and to be fair, some on Wall Street and at the Fed itself — fear the Fed’s — in their view — extremely loose monetary policy will eventually create much higher inflation or dangerous asset bubbles. They also view the Fed as enabling Washington’s out-of-control deficit spending. While many libertarians and followers of Ron Paul would like the end the Fed, many congressional Republicans would be happy merely changing the Fed’s legal mandate to one that focuses soley on keeping prices stable. The Fed’s job is to keep inflation at 2% or so — and nothing more. And right now, the Fed – as they say on Twitter – “is not doing it right.”

At this point let me quote Oliver Cromwell who in 1650 wrote the Church of Scotland, making the following plea: “I beseech you, in the bowels of Christ, think it possible that you may be mistaken.”

The humble purpose of this panel today is to explore the idea that the current … consensus … center-right on the Bernanke Fed — and how to conduct monetary policy in general — may indeed be mistaken.

And we will attempt to do this through the lens of market monetarism, perhaps the first economic theory birthed by bloggers, albeit ones with PHDs in economics. Market monetarism is actually an update of the monetary policy theories of Milton Friedman. To broadly generalize, market monetarists argue the following:

– An overly tight Fed in 2008 turned a period of economic weakness or a mild downturn into the Great Recession, a minor replay of the Great Depression;

– Low interest rates are likely a sign monetary policy is too tight rather than too easy;

– The Bernanke Fed’s bond buying program, unemployment targeting, and new communications strategy have actually moved the central bank in the right monetary direction, toward a strategy of targeting the level of nominal gross domestic product.

And it is NGDP targeting that is central to market monetarism. Instead of directly trying to keep inflation stable and unemployment low, the Fed should instead announce its intention of taking whatever action necessary to maintain a long-run nominal GDP growth rate target.

This rules-based approach would create long-run economic certainty for business, investors, and consumers – and make it less likely the US would again suffer another severe recession or financial crisis.

The headline on Kevin’s otherwise fine piece is “Conservatives for the Federal Reserve.” Well, that’s not quite true.

1. As I mentioned above, market monetarists tend to think the Bernanke Fed blew it in 2008. Not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%.

2. If the Fed had adopted NGDP level targeting — or even the current policy with a better communications strategy — the Fed balance sheet likely wouldn’t be nearly as big today. As it is, the Fed’s current bond buying policy would be more effective if the central bank indicated how quickly it would like to pass its unemployment thresholds.

3. Maybe a better headline would be “Conservatives for a Federal Reserve” since I have little interest in dissolving the central bank. Rather, by adopting NGDP level targeting along with a peg to NGDP futures contracts, it is possible to recreate the Fed as a rules-based, market-driven institution better able to ensure a more stable macro background.

17 thoughts on “Don’t end the Fed, mend it — just not the way most GOPers want to

  1. Economic growth by itself is not inflationary.So Bernanke is correct in his policy that unemployment is the gravest threat to the recovery.When and if inflation rises would be a fantastic outcome,a 2-4 percent CPI would be the official end to this modern day depression.I pray for moderate inflation,when the CPI hits 3 percent I’m going to get up and do cartwheels throughout my living room crying “this depression is finally over,good god almighty it’s over”.Inflation in the US economy is a beautifull thing.Deflation in the US economy is a thing to cry big tears over.

    • No, economic growth is not inflationary.

      Increasing the money supply is inflationary. You don’t need to pray for this, Bernanke is hard at work at it right now.

      The fact is that economic growth and inflation aren’t connected. Inflation creates bubbles, like the housing bubble we just had.

      Sound economic growth often occurs during periods of deflation. It’s natural in times of economic growth, without massive money creation, for prices to fall.

      You can do cartwheels all you want, but a CPI of 3 percent will not signal the end of the depression.

      More money does not mean more production, or more wealth. It is merely a method that government uses to disguise the effects of it’s spending. It’s better thought of as a tax, as it saps the value of people’s money.

      That the depression has lasted as long as it has, depsite unprecedented money creation should tell you something. It doesn’t seem to, but it should. All it is doing is blowing up the next bubble.

  2. WRONG!
    End the fed. It’s run by banksters. You actually think that you can “mend” the ways of the banksters and that they won’t just find another “loophole” to go around your “amendments”?
    Geez, if you think so, I have a nice bridge in Brooklyn to sell you.
    There’s NO REASON for the Fed to exist. The TREASURY it the CONSTITUTIONAL institution that should be doing with the Fed does and it won’t charge “interest” (extortion) that continues the FRAUD of a “national debt” that takes an enormous part of the budge.t
    GROW UP and END IT NOW!

  3. An examination of the ECB’s own web site establishes that inflation of consumer prices in Europe in 2008 broached 4 per cent during the summer, obliging a contraction there by treaty. Even had the Fed done nothing during this time, the ECB action, coupled with the usual seasonal fluctuations, would have drained the U.S. system of reserves during the fall. I strongly disagree with Bernanke’s handling of the current policy; however, focusing on him probably is a waste of time. The real culprit was and remains government-backed central banking orchestrating the long-established fractional-reserve system. America used that system even before it had any central bank, and any historian will concede that we had numerous depressions then. The Fed can make them worse, but it cannot eliminate them altogether, nor would blowing it up.

    Also, let’s assume we got rid of the Fed: Then what would happen? The positive (from a libertarian point of view) is that the green-seal bank notes would go out of use and (one presumes) be replaced by gold or silver coin. This would limit, if not eliminate, inflation and put an end to some legalized paper-money frauds. However, it simply is short-sightedness to assume central banking would end — banks simply would organize a (private) central bank of their own which likely would possess all of the ancient flaws.

    What reasonably would happen were such a system to fall apart completely? Under fractional reserve, the money created by banking operations simply would disappear in the bankruptcies, and a massive and violent contraction of the currency would ensue. That’s precisely what happened in the early 1930s, and we all know the consequences.

    The question before us therefore is not whether we get rid of the Fed or fix it. It is whether we can formulate a policy capable of redressing the underlying systemic weaknesses.

    • What reasonably would happen were such a system to fall apart completely? Under fractional reserve, the money created by banking operations simply would disappear in the bankruptcies, and a massive and violent contraction of the currency would ensue. That’s precisely what happened in the early 1930s, and we all know the consequences.

      The problem with the 1930s argument is that it ignores the credit expansion that created the bubble in the latter half of the 1920s. The Fed created the bubble that burst when the market crashed and politicians overreacted. If the Fed did not exist the bubble would not have been created in the first place. (Not only that but the US could not have entered WW I and could not have prolonged that war. No Lenin. No Hitler. No Fed. I would take that.)

      • I’ve no doubt that the Fed exacerbated the situation then (and Bernanke in the past has admitted just that). Furthermore, they knew that then (see Dewing’s Financial Policy of Corporations).

        Your argument does not work beyond that. Similar processes intervened in 1873 and most certainly in 1893, before the Fed even existed. Not having a central bank did not STOP a business depression, though it can be argued that things would have been worse with more central co-ordination. Also, the problems in the early Thirties certainly were not independent of the collapse of the Kredit Anstalt in 1931, and despite what the Demodonkeys say, Herbert Hoover was NOT responsible for a big bank blowing up in Austria.

        • Your argument does not work beyond that. Similar processes intervened in 1873 and most certainly in 1893, before the Fed even existed.

          The problem with 1873 was the result of the government going off the gold standard during the Civil War. The National Banking Act of 1863 and 1964 created a central-banking-type of money system that led up to the Panic of 1873.

          And I do not see how you can blame the Panic of 1893 on anything but the government’s fumbling of the monetary system. During that time there were signs that the inflationists would win the day and would remove the gold standard. The problem was solved when the Cleveland administration repealed the Sherman Silver Purchase Act of 1890.

          I find it interesting that during the Panic of 1893, bank depositor losses came out to 0.1 percent of GDP significantly less than what we have seen since the Fed has been formed. And even though unemployment was quite high and in the low teens during the Panic of 1893 that is still much better than the situation now, which would measure to be more than 20% if we used the same methodology. And I do not see how a period during which there was a massive investment in the production of oil, steel, railways, etc., could be seen as weak. Increased productivity created a deflation of around 1.9% or so and real wages went up for workers. While the increased productivity rates meant a huge dislocation in the labour market people wound up leaving the farms and finding new jobs in an economy that was structurally sound.

          And for those who keep arguing that you need a central bank to deal with money ‘shortages’ we point to examples of private solutions in 1893, and 1907.

          The simple fact is that having a Fed that continually increases the supply of money means that government is no longer restrained by the discipline of a hard money standard and that the funding of wasteful activities like war and individual or corporate welfare programs. The Fed is in the business of expanding government, bailing out the banks, and creating inflation and bubbles. None of those are useful activities and we would do better without the central planners intervening in money creation or the bond markets.

          • Regardless of what the NBA did, what it did NOT do was create a government-controlled central bank. For this reason, getting rid of the government-controlled central bank would not cure the problem and, indeed, would revert us right back to the 1873 situation (since the NBA, as amended by the Federal Reserve Act as amended, still is in effect).

            As for 1893, I’ve never seen any credible explanation of it which did not start with events in Europe in 1889-1890, specifically the fall of the House of Barings in England in 1890. America avoided immediate effects because of the two monster harvests in 1891 and 1892, but eventually the overcapitalization of American railroads by foreign (especially German) firms caught up with us. Again, Dewing, and see also Maury Klein’s account of the U.P. bankruptcy in volume 1 of his Union Pacific.

            Whatever effect the Cleveland Administration may have CONTRIBUTED to the panic (and let’s remember that von Mises is more than a quarter of a century down the road), the fact remains that domestic policies had little to do with it. That’s one of the reasons the depression was characterized more by railroad failures than bank failures.

          • Regardless of what the NBA did, what it did NOT do was create a government-controlled central bank. For this reason, getting rid of the government-controlled central bank would not cure the problem and, indeed, would revert us right back to the 1873 situation (since the NBA, as amended by the Federal Reserve Act as amended, still is in effect).

            Actually getting rid of the Fed would cure the problem if the government stopped meddling with the banking sector and bailed out the gamblers who take too many risks.

            As for 1893, I’ve never seen any credible explanation of it which did not start with events in Europe in 1889-1890, specifically the fall of the House of Barings in England in 1890.

            I agree that the fall of Baring Brothers was a trigger. But the American problem was created by Congress, which subsidized railway building and triggered a land boom that had to go bust eventually.

            America avoided immediate effects because of the two monster harvests in 1891 and 1892, but eventually the overcapitalization of American railroads by foreign (especially German) firms caught up with us. Again, Dewing, and see also Maury Klein’s account of the U.P. bankruptcy in volume 1 of his Union Pacific.

            James Hill did not have the problems that Union Pacific did. He did not use government subsidies and made sure that he picked the best grades and straightest routes. Because he ran a tight ship the trouble that destroyed many of his competitors was not much of a problem for his railway. In fact, while the other transcontinental railways were going bust during the panic he increased his own net worth significantly.

            Whatever effect the Cleveland Administration may have CONTRIBUTED to the panic (and let’s remember that von Mises is more than a quarter of a century down the road), the fact remains that domestic policies had little to do with it. That’s one of the reasons the depression was characterized more by railroad failures than bank failures.

            We know why the railways went bankrupt; they overbuilt and did not manage their costs well. As I pointed out, the railway that did not use government subsidies and kept its costs in line came through very well during the panic as it increased traffic and reduced operating costs.

            I think that you are making my point for me. Government meddling does not work very well and giving a quasi-government organization like the Fed the power to transfer wealth from workers and investors to its owners cannot be justified on utilitarian or moral grounds.

        • Not having a central bank did not STOP a business depression, though it can be argued that things would have been worse with more central co-ordination.

          First, when you have most of your economy dependent on agriculture it is easy to have business depressions just due to changes in the weather. Second, during most of your history the government has meddled in banking and credit creation so it is not surprising to see booms and busts that are related to that credit creation.

          Also, the problems in the early Thirties certainly were not independent of the collapse of the Kredit Anstalt in 1931, and despite what the Demodonkeys say, Herbert Hoover was NOT responsible for a big bank blowing up in Austria.

          They were dependent on the Fed’s credit expansion during the second half of the 1920s. If you are interested there are great books on the subject.

          America’s Great Depression

          The Forgotten Man

          Economics and the Public Welfare

          • This is libertarian provincialism (as if the Fed were the only entity expanding credit in the 1920s or very early 1930s). The reality is that Ludwig von Mises refused to take a supervisory role over the Anstalt precisely because he knew what it had been doing, and that die Krach was coming.

            Furthermore, if you’ve really read Rothbard, you know that the problem lies beneath the orchestration provided by a central bank. Indeed, in The Mystery of Banking, Rothbard explicitly admits that the problem lies in the history of the development of embezzlement law (one of the reasons the positivists like Friedman never could reach the problem — they’re methodology always took the underlying legal structure as a given, as if it were a law of nature). There are good books on this subject, e.g., George P. Fletcher, Rethinking Criminal Law.

  4. END THE FED NOW or IT will END the Republic.
    THEN CLEAN THE DEPT. OF THE TREASURY.
    THEN END THE DEPT. OF EDUCATION…
    But who’s listening?

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>