Was the Fed a Good Idea?
This year marks the 100th anniversary of the founding of the Fed with the Federal Reserve Act of 1913. With a hundred years of experience behind us, it seems like a good time to evaluate the performance of the nation’s system of central banks. To this end, on November 14, the Cato Institute held its 31st annual Monetary Conference, entitled “Was the Fed a Good Idea?”
A pretty heady group of economists, policymakers, business/economics writers, and bloggers converged on Washington to participate. The attendees were too many to list, but a few examples may serve to give the reader a sense of the proceedings.
As former chairman and CEO of BB&T, John Allison was certainly well-qualified to talk about the Fed’s performance through the recent financial crisis. Current and past Federal Reserve Bank Presidents Charles Plosser (Philadelphia) and Jerry Jordan (Cleveland) offered perspective from the lectern, while former Fed Governor Wayne Angell commented from the floor. (I remember Wayne well from my time at the Board of Governors, and he doesn’t seem to have slowed down a bit.)
We got a European perspective from Leszek Balcerowicz, chairman of the National Bank of Poland, and Athanasios Orphanides, formerly a governor of the Central Bank of Cyprus and an advisor to the Federal Reserve Board. Orphanides also served on the Governing Council of the European Central Bank.
Rep. Kevin P. Brady, chairman of the Joint Economic Committee, and Rep. Jeb Hensarling, chairman of the House Financial Services Committee, offered Congressional representation. Lawrence H. White (George Mason University) and George Selgin (University of Georgia), known in particular for their writings on free banking, are past participants in AIER programs. Lewis E. Lehrman, of the Lehrman Institute, gave the closing address.
The issues addressed at the conference include lessons from a century of U.S. central banking, alternatives to discretionary government fiat money, comparisons between the Fed and the market as bank regulators, and the case for a National Monetary Commission and fundamental reform.
Charles Plosser gave the keynote address to discuss the Fed’s essential role and to propose how this institution might be improved. Plosser offered four suggestions for the central bank to limit discretion and improve outcomes and accountability.
First, the Fed should abandon its mandate of maximum employment and solely focus on price stability. Second, the Fed should only hold Treasury securities on its balance sheet. Third, the Fed should use a systematic and rule-like approach to conduct its monetary policy. Fourth, the Fed should limit the boundaries of its lender-of-last-resort credit extension.
Plosser also argued that the Fed’s mandate should have its emphasis on the longer run. He said “…focusing on short-run control of employment weakens the credibility and effectiveness of the Fed in achieving its price stability objective.” In order for the public to hold the Fed accountable for its monetary policy, he offered three solutions: “Simplify the goals, constrain the tools and make decisions more systematically.”
When asked about the Fed’s current 2 percent inflation target in the Q&A session, Plosser argued that 2 percent is just a number the Fed used to show the public its commitment and ability to achieve policy goals.
But if 2 percent is just a random number picked by the Fed to only serve that purpose, why didn’t the Fed pick 3 percent or 4 percent? Higher numbers would make it easier for the Fed to claim inflation is under control.
It is true that the central bank cannot control real economic variables, at least not in the long run, and the public has come to expect too much from its central bank. But since price stability is the Fed’s primary objective, isn’t it reasonable for the public to expect central bankers to rigorously and analytically determine its inflation target? If “simplifying the goals” means randomly selecting a number for inflation target without considering its impact on the economy, maybe this is not the right approach.
Scott B. Sumner, a professor of economics at the Bentley University, gave a controversial presentation on nominal GDP (NGDP) targeting that brought on a wide-ranging audience discussion. Sumner argued that the optimal monetary rule is for the Fed to target NGDP instead of targeting a certain level of inflation or attempting to achieve maximum employment. He started out by showing the co-movement between NGDP and total losses to the U.S. banking system during 2008-2009 to argue that the decline in NGDP, not failure of the financial markets, caused the Great Recession.
We would argue that NGDP is the market value in current dollars of final production, namely a measure of the economy unadjusted for inflation. Hence, changes in NGDP capture upward and downward growth of the economy.
When the housing bubble burst in 2007-2008, sharply declining housing prices caused quickly spreading financial distress, which resulted in a financial crisis. Disposable personal income started to drop, and consumption and investment went down sharply until 2009, when, as Sumner pointed out, NGDP reached the largest decline since the 1930s. The decline in NGDP only measured the downturn of the economy that was caused by the financial crisis; not the other way around.
There are problems with Sumner’s advocacy of the Fed targeting NGDP rather than inflation. A central bank with authority to control the money supply can only achieve its goal for price stability in the long run and cannot control real economic activity, at least not over time. The only long-term role for the central bank and monetary policy in ensuring economic growth or NGDP growth is in providing price and financial stability to provide a healthy environment for growth to occur.
White believes that there is a single monetary standard in the economy that requires alternative monies to be transformed from the existing money. But he told stories about the Liberty Dollar and E-gold to discuss alternative monetary standards that might arise in parallel with the fiat dollar. He concluded that the legal barriers to open currency competition in the U.S. include anti-money-laundering laws, money transmitting licensing requirements, capital gains taxes, state sales taxes on precious metals, and banning private coinage.