Stephen Foley: Let's call a halt to this Fed-bashing. In the longer view its record is strong
Saturday 20 November 2010
US Outlook: Really thoughtwe had this one licked. Last year, when internet star, and one-time candidate for the Republican presidential nomination, Ron Paul wrote his book End The Fed, it seemed he might be moving his central-bank-bashing agenda closer to the mainstream of US politics. His attempt to bring the Federal Reserve under greater political control (a precursor, he hoped, to destroying it) fizzled out in the discussions on Wall Street reform. But no, we did not have this one licked.
The politicisation of the Fed is a worry all over again, thanks to the fabricated outcry over its $600bn (£375bn) monetary expansion plan. This is the plan that the Fed itself calls quantitative easing and its opponents call "stimulus" in order to associate it with the despised fiscal stimulus last year. It didn't live up to expectations, and now the Fed-haters are back in a more dangerous, virulent and politically powerful form.
The bank was charged after the Second World War with ensuring both price stability and full employment, but some senior Republicans are trying to tinker with that dual mandate. In the fog of ignorant commentary, they have seized their moment to argue the Fed should no longer see to it that every American who wants to work, can. Fed chairman Ben Bernanke ("The Ben Bernank", as he is called in an anti-Fed cartoon circulating on YouTube) looks decidedly uncomfortable. Ron Paul and his fans are licking their lips. The rest of us should get educated, get active and protect ourselves by protecting the Fed's independence.
So, can someone from the political and economic mainstream please write a book called Defend The Fed? I want to suggest a few chapter headings:
If the Federal Reserve did not exist, it would be necessary to invent it. The economic world before its creation was nasty, brutish and – for far too many businesses – short. The bank was formed in 1913 to halt a string of financial panics, including a whopper in 1907. Panics (as anyone who was alive two years ago knows) lead directly to deep recessions, widespread bankruptcies and high unemployment.
The Fed isn't all-powerful to stop excesses from building up, but by acting as lender of last resort, and smoothing the economy through interest-rate changes, it makes panics fewer and further between and it makes recessions shorter and shallower.
'Let me see if I can think of anything...'
Even beyond an unquantifiable number of panics averted, and recessions that weren't, the Fed can point to more policy successes than its opponents can point to failures. It was creative, flexible and energetic in responding to the unfolding credit crisis in 2008. It has kept deflation at bay for 60 years. It squeezed inflation out of the US economy through painful interest-rate rises in the early Eighties. Former chairman Alan Greenspan warned of "irrational exuberance" ahead of the dot.com bubble.
'Printing money' is not what you think
Forgive me, reader, for I have sinned. I have used "printing money" as shorthand for electronically creating bank reserves out of thin air – which is what the Fed is doing to the tune of $600bn through quantitative easing. These are not banknotes leaving the Fed building in wheelbarrows. Weimer Republic-style hyperinflation is not in prospect. Even in normal times, the Fed is manipulating the money supply on a daily basis; that is how, in practice, it lowers or raises interest rates. When it comes to the total dollars in the economy, the amount of lending activity that banks decide to do is actually much more important. It's complicated. The Fed can – and will – unprint money.
'Enough about the gold standard already...'
Talk of a modern gold standard is not on the political or economic agenda in the US or internationally, but the idea attracts so much excitement and simplistic commentary all over the web (and, of course, it is the main proposal in End The Fed), that the author of Defend The Fed ought to collate the reasons why the idea is terrible. For starters, it makes an economy inflexible, prone to shocks, and at the mercy of mining companies and jewellery collectors. Having a fiat currency is no more conceptually bizarre than imbuing one particular metal with magic monetary powers.
Why an independent Fed is so important
The irony is that while The Ben Bernank's chairmanship has aimed to demystify the Fed, the central bank is subject to more public misunderstanding than ever. It is also a bigger political football than ever – and that should concern us all. Markets are volatile enough without having to factor in political interference. If they have to add that in, too, interest rates in the US will have to be higher – which will make clawing back lost prosperity that much harder. The Fed, meanwhile, also stands as a bulwark against the impending fiscal crisis that the US government faces in a decade or two.
For all the Fed's imperfections, does anyone really think that allowing politicians to meddle will improve its effectiveness?
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