As I discussed in this article, Congress has given the Fed a “triple mandate” to maintain 1) maximum employment; 2) a stable price level; and, 3) low interest rates. I also showed in that article that the Fed has failed to achieve these mandates again and again over the past 112 years.
This is not an accident of history. Given the nature of central banking and artificial money creation, it is impossible to achieve all three of these mandates, because monetary inflation is the primary factor that causes price inflation, the boom-bust business cycle, and later high interest rates. Ludwig von Mises discovered this over a century ago and this Mises Institute documentary explains it clearly.
But since the Fed is an “independent” government agency, the Fed suffers no consequences for failing to achieve its mandates. Indeed, the bureaucrats at the Fed are practically worshiped in Washington, DC and on Wall Street for their supposed ability to centrally plan the economy like the old Soviet Politburo. But at least some Congressmen understand economics, like Thomas Massie, who has introduced a bill to abolish the Fed.
In the meantime, the American people are suffering once again from the Fed’s endless manipulation of money and credit. Currently, the US economy is suffering from the dreaded double whammy of “stagflation”—high inflation and unemployment—which conventional Keynesian economics cannot explain. And it is likely to get worse, as I discuss below.
Only Austrian Business Cycle Theory Can Explain Stagflation
As Murray N. Rothbard discussed here, only Austrian Business Cycle Theory (ABCT) can explain what causes stagflation. Traditional Keynesian economics—which still rules the economics profession and the thinking of Federal Reserve economists despite its repeated failures—argues that the government can “fine-tune” the economy to prevent high inflation, unemployment, and interest rates.
But Austrian Business Cycle Theory shows why this is impossible. This theory explains that capital goods prices rise relative to consumer goods in an economic boom and fall relative to consumer goods in an economic bust. Prior to the Fed, all prices fell in an economic bust, including consumer prices. But modern central banking has caused consumer prices to continue to rise even in a bust, as Rothbard explained:
Now that the supply of money — and hence general prices — is never allowed to fall, the rise in relative consumer goods prices during a recession will hit the consumer as a visible rise in nominal prices as well. His cost of living now goes up in a depression, and so he reaps the worst of both worlds; in the classical business cycle, before the rule of Keynes and the Council of Economic Advisors, he at least had to suffer only one calamity at a time.
Inflation and Interest Rates Remain Stubbornly High
In response to government lockdowns over the covid virus in 2020, the Fed increased the money supply by 40 percent. This led to the highest price inflation in 40 years, with CPI inflation reaching as high as 9 percent in 2022. This forced the Fed to hike interest rates at the most aggressive pace since the early 1980s, raising rates by more than five percentage points in 2022 and 2023.
This tighter monetary policy caused the money supply to fall over 10 percent in 2023, the largest money supply decline since the Great Depression. It also caused the yield curve to be inverted, with long-term Treasury bond yields falling below short-term Treasury bill yields, for more than two years. That was longer than anytime in history, even longer than the previous longest time, which was before the Great Depression. Historically, whenever the yield curve has been inverted for a significant period of time due to Fed tightening, a recession has followed.
Despite this aggressive tightening, inflation and interest rates still remain stubbornly high. The latest CPI inflation increased 2.4 percent and the Fed’s favorite inflation metric, Core PCE inflation, increased 2.8 percent. That is still above the Fed’s arbitrary 2 percent target and well above the roughly zero percent inflation that would enable the Fed to achieve its mandate of a “stable price level.” And, due to this high inflation and the out-of-control federal spending that the Fed enables, Treasury interest rates are still higher than Congress would like at over 4 percent.
Consumer inflation expectations are also high and rising. The latest University of Michigan survey shows inflation expectations for the coming year skyrocketed from 5 percent last month to 6.7 percent this month, which is the highest reading since 1981. This does not bode well for the demand for money and future inflation.
As a result of the higher interest rates and federal debt, federal interest expense has more than doubled since 2020 to over a trillion dollars, making it the second largest line item in the federal budget after Social Security. Clearly, this failure by the Fed to maintain low interest rates is not something Congress wants.
Recession Signs Abound
As noted above, a recession typically follows aggressive Fed rate hikes and an inverted yield curve like night follows day. There are currently many signs that a recession is coming, if one has not already started. Here are four of those signs:
- The Conference Board’s US leading economic index has been declining for more than three years. Such a long and persistent decline in the leading economic index has historically provided an excellent recession warning.
- The unemployment rate has risen from a low of 3.4 percent in 2023 to 4.2 percent now—a 0.8 percentage point increase. Historically, a recession has always occurred when the unemployment rate has increased that much.
- The latest University of Michigan consumer survey shows sentiment has fallen to near the lowest levels in history, levels which are only seen in recessions historically.
- Based on this survey, two-thirds of consumers expect higher unemployment, which is the highest level since the Great Recession, as shown here:
Conclusion
It is clear that the Fed has proven to be an utter failure in trying to centrally plan the economy and achieve the mandates set by Congress of high employment, stable prices, and low interest rates. The latest economic data suggests Americans will have to endure another “stagflationary” recession, thanks to the Fed. The only solution to ending this economic chaos once and for all is for Congress to abolish the Fed for failing to achieve its mandates. If not, Congress should at least be honest and say the Fed has no mandates and can create whatever havoc they want, regardless of what the American people want.
