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The Fed

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Tags The FedU.S. EconomyInterventionismMonetary Theory


Phil Gramm of Texas thinks in free-market terms, but two factors stand between his policies and a consistent defense of market theory: a) he's a politician, and b) he's not an adherent of the Austrian School. Hence, his call for the Fed to acquire more power to manage the economy.

The very good editorial below describes the problem perfectly. It is wrong only in saying that the job of the Fed is to maintain stable prices. In fact, the price system is far too complex to be maintained at some stable level; no price index can fully portray complex price movements among good, industries, and sectors.

Moreover, the demand that the Fed maintain stable prices implies that it should interrupt broad trends toward lower prices. Hardly anyone bothers to explain why would be such a terrible thing for consumers to enjoy continually rising purchasing power.

What is the job of the Fed? In a free market, it would not have one. See references at the end of this editorial for more details.

Investor's Business Daily
March 19, 1999

It's Not The Fed's Job

What could Sen. Phil Gramm be thinking? Apparently not content with the Federal Reserve Bank's current charge, the Texas Republican wants Congress to add to the bank's list of duties. He suggests rewriting law so the Fed will be also responsible for economic growth.

Gramm, a heretofore hard-line defender of free-market principles, should know better.

In addition to its current statutory responsibility for seeking ''maximum employment, stable prices and moderate long-term interest rates,'' Gramm wants what he calls ''a broader definition'' of the Fed's goals, according to news reports.

Gramm rightly points out that unemployment is not very good as a single benchmark for the economy. ''You could have relatively full employment and have a stagnant economy,'' he said. But to give the Fed the mission of managing the economy misunderstands the Fed's power.

Politicians love to focus on employment rates. After all, real people are laid off or get work. And they vote. That's why Congress passed the employment provisions in the Humphrey-Hawkins Act in 1978.

But putting people back to work is rather difficult if the controlling agency can only boost or dampen the money supply.

So does the Fed's duty to seek ''maximum employment'' mean that it must try to boost economic growth? Hardly. It does enough for growth by simply maintaining stable prices. With money that is not being eroded by pump-priming inflation, Americans can make more efficient economic choices.

Though he would disagree with this characterization, Gramm comes off like a modern liberal when he says the Fed should be more active in managing the economy.

The economy is not a program to be managed by the Fed, the federal government or any other organization. It's too important to leave to committees, central bankers (read planners) and politicians.

The economy can only be managed by those who participate in it, the tens of millions of Americans whose hard work, creativity and buying power has spurred it to new heights.

Gramm's proposal would open the door to a lot of mischief, depending on who's in charge. Under Fed Chairman Alan Greenspan, Gramm's proposal wouldn't be too harmful. Greenspan's a temperate soul who has a good idea of where government's bounds lie.

But let one of President Clinton's -or possibly Al Gore's - appointees take over as Fed chair, and look out. Can there be any doubt that one of their appointees would be sympathetic, if not devoted, to the micromanaging envisioned by John Maynard Keynes? The mere hint of an economic downturn would likely spur them to turn on the money machine - all in the name of growth.

Instead of expanding the Fed's powers, Congress should limit them. The Fed's only tool is the money supply. Therefore, it should stick to damping down inflation. By focusing on that goal only, Greenspan's Fed has kept prices relatively stable for eight years. While he has paid erudite lip service to the other mission of the Fed - full employment - he has shown he understands the best role of the central bank.

Gramm's remarks suggest he doesn't understand this role - which is hard to believe, given his economics training. We hope his analysis is a little deeper than what was reported. If not, then he's giving future Keynesians a ticket to inflate.

(C) Copyright 1999 Investors Business Daily, Inc..



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