April 26, 2014

April 26, 2014 | Commentary on Economy, Federal Reserve

Dreams of a Central Planner

The Federal Reserve has arrived at last.  Exhibit A: The tremendous number of people interested in who would be confirmed as the new Fed Chairman last January.

For monetary geeks like me, it’s an exciting development.  It gives me a chance to talk about topics I’ve been interested in for decades, but now with more than two people.

I sincerely hope to use this column to broaden the conversation surrounding the Federal Reserve.  Over time, I’ll talk about the usual topics – quantitative easing, tapering, interest rates, etc.  But there’s so much more to monetary policy than these narrow issues.  What about the very purpose of the Fed itself?

Most students are taught that the Federal government stepped in to calm the monetary chaos in the US.  Supposedly, the fact that people used many different types of money made everyday life unbearable, and the establishment of the Federal Reserve finally solved that problem.

We’re also told that the Fed is necessary to stabilize the economy.  But are these stories true or just unifying myths—the economist’s equivalent of George Washington chopping down a cherry tree?

The conventional story contains some truth, but it glosses over—or completely ignores—many key facts.  It’s not surprising that many of these important details remain unknown outside of monetary enthusiasts’ circles.  But what is surprising is the almost unquestioning belief that most economists seem to place in the Federal Reserve.

Very few modern economists, for instance, would argue that we can centrally plan an economy.  Most realize that large-scale central planning leads to economic disaster because planners can never have access to all the required information.  Even if they did have such access, the fact that people are motivated by their own self-interests makes them susceptible to special interests.  All of these issues, as well as the absence of market prices, ensure that central planners will waste resources on (most likely) a massive scale.

Some economists – though certainly not all of them – understood this issue even before the collapse of communism in the late 1980s.  That event solidified the notion that large-scale central planning is a bad idea. Paradoxically (and unfortunately), too many economists remain convinced that small-scale central planning is necessary.

And even if we think they can do all of the above, why should we anticipate that these committee members would be able to force the economy to hit all of their targets?  Whether it’s wise or foolish, this is exactly what we’ve asked of the Fed for nearly a century.

There have certainly been some disastrous consequences: the Fed is far from blameless in the Great Depression of the 1930s and the great stagflation of the 1970s.  Yet, at nearly every turn, Congress has given the Federal Reserve more power.

Even though the Fed was the primary regulator of bank (and financial) holding companies well before 2008, Congress greatly expanded the Fed’s regulatory authority in the aftermath of the financial crisis.  Congress may have absolved the Fed of any responsibility for its previous mistakes, but it’s vital that U.S. citizens don’t make the same mistake.

Over the course of the next year, this column will raise many tough questions that may not have easy, comforting answers. But in the spirit of a great Nobel laureate, we will constantly discuss how little economists really know about what they imagine they can design.

 - Norbert Michel is a research fellow at The Heritage Foundation’s Roe Institute for Economic Policy Studies.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies

Originally appeared in Forbes