Americans need to start talking about the Federal Reserve
Published: Friday, October 18, 2013
Updated: Sunday, October 20, 2013 22:10
It’s about time that our leaders, both in politics and the media sit down for an honest talk on about the subject of monetary policy. It might not make for good one liners like taxes or regulations do, but it’s important. monetary policy is the function by which we create our money. Monetary policy in the United States is handled by the Federal Reserve System. The Federal Reserve is a central bank. They decide how much money the Treasury should create, and just as importantly what should be done with that money.
Primarily it buys up short-term treasury notes, or government debt through a process called open market operations. This can serve to increase the base monetary supply, and to keep short term interest rates low. You see the Fed, as it’s called, has the authority to create money. When this money is used to by government debt, or debt of any kind really, it increases the money supply. Now, instead of government bonds, banks have money that they can lend. This increase in the supply of money naturally drives down interests rates. Interest is the price of money. In this way money functions like anything else. If we take all other things to be the same, and the supply of widgets is increased, prices would naturally fall. This cheap money as it’s called can then be loaned out to consumers, and then be used to buy houses, or start new businesses. This process also makes it easier for our government to run up deficits. The proceeds from those deficits going towards jobs programs like Obama’s Stimulus Package.
Sounds great right? Well there are problems, and not just a couple. Inflation for one. If the money supply increases faster than the economy grows then we get inflation. Inflation is a rise in the price of goods and services. At low levels inflation can be negligible, even beneficial according to some schools of thought. Too much inflation can cause economic chaos, and even destroy a nation’s currency. If inflation is paired with a stagnating economy, or stagflation for short, as we saw in the late 70’s, central banks can be left helpless. Another major problem presented by centralized banking is the risk of male investment, or even asset bubbles. We saw this in the lead up to the Great Recession. The money produced by the fed made its way into the housing market. These cheap loans led to an increase in the demand for housing. This increase in demand led to an increase in price. The cheap money kept flowing and the cycle continued. Eventually the housing bubble burst, and here we are five years later. These problems have led many to take a hawkish position on printing. Maybe using the printing press to bolster the economy isn’t such a good idea.
However, the results of too little printing can be just as damaging. The late great economist Milton Friedman was quoted as saying. “The Great Contraction is tragic testimony to the power of monetary policy.” You see the Great Depression was primarily of monetary origins. If you thought it was greedy bankers or speculators you’re wrong, and you’re probably a high school history teacher to boot. The economic reality is that the Federal Reserve tightened monetary policy at precisely the moment it should have been engaged in the production of money. As banks started to fail, as they sometimes do, the Federal Reserve did nothing to mitigate the crisis. As banks collapsed deposits were destroyed. The monetary supply actually shrank. “The quantity of money in the United States fell by one-third in the course of the contraction,” said Friedman in his work, The Role Of Monetary Policy. Wages and prices fell, and the economy slowed as a result. As recently as 2002 current Fed Chair Ben Bernanke said, “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
I’m not calling for a return to the gold standard. I’m not saying we need to print less money. I’m not saying we need to print more money. To be honest I’m not even remotely intelligent enough to make that kind of call, and the scary part is, I’m not sure anyone is.