Power & Market

How Does the Federal Reserve Fit into Our Constitutional Order?

federal reserve sign

This article is adapted from a lecture delivered to the Federalist Society: 

The Federal Reserve is a fundamental problem for the Constitutional order of the American Republic. How can it be that it considered itself able to unilaterally impose permanent inflation on the country, without legislative debate or approval?

The shifting theories believed by central banks are among the most important of macro-economic factors. For example, William McChesney Martin, chairman of the Federal Reserve Board 1951-1970, rightly characterized inflation as “a thief in the night.” 

In remarkable contrast, the Fed under Ben Bernanke, chairman 2006-2014, explicitly committed itself and the country to inflation forever at the rate of 2% per year, thus assuming that constant inflation should not only be taken for granted, but pursued.

If the purchasing power of the currency continuously depreciates at the rate of 2% per year, as the Fed now promises, in the course of a single lifetime, average prices will quintuple. At 3%, as is sometimes suggested, prices in a lifetime will multiply by 10 times. At 4%, they will multiply by 23 times.

Is this the kind of money the American people want? I don’t think so. It certainly is the kind of money wanted by those who long to expand government power and finance it by an unlegislated inflation tax.

The nature of money and the stability of its value is an essential political and social question. William Jennings Bryan famously proclaimed, “You shall not crucify mankind upon a cross of gold!” On the other hand, we may proclaim, “You shall not drown mankind in a flood of paper money!” Who gets to choose between inflationist money and sound money?

Not the Fed by itself. Regulating the value of the money and deciding whether it should be sound and stable, or perpetually depreciating, and if so, at what rate, are questions profoundly requiring the Congress.

The media is full of references to “the Fed’s” 2% inflation target. But if there is to be such a target, it should be “the country’s” target, not “the Fed’s” target. The Fed’s proposal to constantly depreciate the people’s money should have been presented to the elected representatives of the people for approval or rejection. It wasn’t. Then-Fed Chairman Ben Bernanke went around and talked to several legislators about his inflation target idea, but that entirely different from Congressional debate and approval.

How in the world did the Fed imagine that it then had the authority all on its own to commit the nation to perpetual inflation and depreciation of the currency at some rate of its own choosing?

The only explanation I can think of is pure arrogance. 

Being the most powerful financial institution in the world and the purveyor of the dominant fiat currency seems to have led the Fed to an excessively high opinion of its own authority.

Congress should be aware that the Fed has crucial and dangerous inherent weaknesses. It has demonstrated beyond question its inability to predict the financial and economic future (just like everybody else). It can inflate disastrous asset price bubbles as well as consumer prices. It is unable to know what the results of its own actions will be. This inability is notably shown by its own financial performance: a net loss of $135 billion since September 2022, tens of billions in net losses still to come, capital of negative $92 billion when properly accounted for and getting more negative at the rate of $2 billion a week, and a mark to market loss on its investments of over $1 trillion.

Congress should:

  • First and foremost, amend the Federal Reserve Act to make it clear that setting any “inflation target” requires review and approval by Congress, as a public choice between kinds of money. The Fed does not have unilateral power to decide the nature of the money the government provides to and imposes on the people.
  • Second, legislatively cancel the 2% inflation target announced by the Fed, until the Congress has approved that or some other guidance. For better guidance, I recommend stable prices, a goal already stated in the Federal Reserve Act, but being evaded. This implies a long-run average inflation rate of approximately zero--in other words, a goal of sound money.

All in all, we need to control the powerful and dangerous Fed by using the checks and balances of our Constitutional republic.

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Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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