Friday, 11 July 2014

Was the Fed a good idea?

This is the question considered in a series of papers in the latest issue (Volume 34, Number 2 Spring/Summer 2014) of the Cato Journal.

Passed on December 23, 1913, the Federal Reserve Act was designed to provide an elastic currency that would respond to the needs of trade. Today, the Federal Reserve System is much different than it was a century ago. How well has the Fed performed? Was the Fed a good idea? Can we do better?

The Editor's Note introduces the various papers:
The Federal Reserve Act was passed on December 23, 1913. It was designed to provide an elastic currency that would respond to the needs of trade. There was nothing in the Act about price stability, interest rates, or full employment. The expectation was that the United States would continue to define the dollar in terms of gold, and that the operation of the international gold standard would ensure long-run price stability.

It was widely accepted that “the highest moral, intellectual, and material development of nations is promoted by the use of money unchanging in its value,” as declared by the U.S. Monetary Commission of 1876. The classical gold standard ended with the First World War, and, in August 1971, the dollar became a pure fiat money when President Richard Nixon closed the gold window.

Today the Federal Reserve System is much different than a century ago. How well has the Fed performed? Was the Fed a good idea? Can we do better? To address those and related questions, the Cato Institute brought together some of the most respected monetary scholars and policymakers at its 31st Annual Monetary Conference in Washington, D.C., on November 14, 2013. The papers from that conference are featured in this volume.

In the lead article, Charles I. Plosser argues for a rules-based monetary policy and a “limited central bank” devoted to the primary task of safeguarding the dollar’s long-run purchasing power. Jerry L. Jordan considers the lessons learned from a century of U.S. central banking, while George A. Selgin provides a detailed account of how the Fed has twisted its true record. Athanasios Orphanides, like Plosser, makes a strong case for a “price stability mandate.”

Lawrence H. White examines the Fed’s “troubling suppression of competition from alternative monies” using the examples of the liberty dollar and e-gold. Legal restrictions are also noted by Richard H. Timberlake in his article on “clearing house currency.” Scott B. Sumner advocates rules rather than discretion in the con duct of monetary policy. His preferred rule is to target nominal GDP rather than inflation or the price level.

Since the Panic of 2007, the Fed’s balance sheet and power have expanded dramatically. The Fed’s ultra-low interest rates and quantitative easing have distorted capital markets, increased risk taking, politicized credit allocation, monetized government debt, and allowed the government to expand its size and scope. Moreover, the Fed’s regulatory powers have increased uncertainty and dampened the disciplinary forces of private free markets.

Rep. Jeb Hensarling, the chairman of the House Financial Services Committee, pledges to conduct hearings to hold the Fed account able and help improve its performance. John A. Allison draws on his experience as chairman and CEO of BB&T Corporation to discuss the unintended adverse consequences of top-down financial regulation as opposed to the spontaneous positive results of market-based discipline, given the appropriate institutional framework making individuals responsible for their actions. Kevin Dowd and Martin Hutchinson look at the institutions that helped mitigate moral hazard and harmonize financial markets in the pre-Fed era and compare them to changes in the financial architecture since the creation of the Fed. Their main conclusion is that competitive markets bound by laws of contract and an overarching rule of law that protects private property rights provide incentives to manage risk and avoid the problem of “too big to fail”—a central bank and hordes of government regulators do not.

Rep. Kevin P. Brady, chairman of the Joint Economic Committee, makes the case for a bipartisan Centennial Monetary Commission to examine the Fed’s history and consider alternatives to pure discretionary government fiat money. He takes seriously the constitutional mandate for Congress to ensure stable-valued money. Gerald P. O’Driscoll Jr. considers the prospects for fundamental monetary reform and the strategies to promote such reform. R. David Ranson argues that the Fed’s over reliance on conventional statistics to guide its policy and its politicization have led to failed policies. In particular, by distorting interest rates and trying to “stimulate” the economy, the Fed has actually slowed recovery. Ultimately, real reform of the monetary and financial system requires that voters understand the limits of central banking and the benefits of limited government and free markets.

In the final article, Lewis E. Lehrman, a member of the President Ronald Reagan’s Gold Commission in 1981, makes a compelling case for returning to a classical gold standard, not only to protect the purchasing power of the dollar but to prevent the federal government from using the printing press to pay its bills.


A Limited Central Bank 

By Charles I. Plosser

A Century of Central Banking: What Have We Learned? 

By Jerry L. Jordan 

Operation Twist-the-Truth: How the Federal Reserve Misrepresents Its History and Performance 

By George Selgin

The Need for a Price Stability Mandate 

By Athanasios Orphanides

The Troubling Suppression of Competition from Alternative Monies: The Cases of the Liberty Dollar and E-Gold

By Lawrence H. White 

Clearing House Currency

By Richard H. Timberlake Jr. 

Nominal GDP Targeting: A Simple Rule to Improve Fed Performance 

By Scott Sumner

Fed versus Market Regulation 

By Rep. Jeb Hensarling

Market Discipline Beats Regulatory Discipline 

By John A. Allison

How Should Financial Markets Be Regulated?

By Kevin Dowd and Martin Hutchinson

The Case for a Centennial Monetary Commission 

By Rep. Kevin Brady

Prospects for Fundamental Monetary Reform 

By Gerald P. O'Driscoll Jr.

Why the Fed's Monetary Policy Has Been a Failure 

By R. David Ranson

The Federal Reserve and the Dollar 

By Lewis E. Lehrman

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