Nine times. If you’ve seen the classic ’80s film Ferris Bueller’s Day Off, you recognize and can hear the principal’s voice. Ferris, an overconfident and overzealous teenager, has managed to ditch school with his two pals—again. The movie depicts a classic cat-and-mouse game between the principal, who is determined to catch the reckless high schoolers, and Ferris, who eludes him at every turn. When the principal calls Ferris’ mother to report his absence, she is flummoxed to learn that Ferris has already missed nine days of school. “I don’t remember him being sick nine times!” Americans are equally flummoxed that the Fed Reserve has raised its benchmark interest rate nine times since March of last year. Many economists predict that more rate hikes are looming, at least through the summer. Nine times … and counting.
The Fed is playing its own game of cat-and-mouse with the economy. Managing monetary policy is an art, not a science, but it must respect the laws of economics and not be used whimsically or ideologically to satisfy political interests. The Fed and the American people would do well to remember that the laws of economics persist, despite their political inconvenience, and that technocratic management of economic affairs is always a bad idea. This is why Nobel laureate Milton Friedman called for rules over discretion when it came to monetary policy. Rules provide necessary ex-anteboundaries for bankers-turned-bureaucrats, who are increasingly under great political pressure to engineer a robust and healthy economy.
If we have learned anything from the socialist calculation debate, it’s that knowledge is elusive, tacit, and local. The economy is not the product of any mind, and we cannot conjure up economic outcomes according to our wishes. The lesson delivered powerfully time and again is that technocratic planning, whether fiscal or monetary, doesn’t work.
Just to remind everyone, the Federal Reserve is the U.S. central bank and required by Congress to conduct monetary policy, with the challenging task of fulfilling what has come to be known as its “dual mandate”: to maintain both price stability and full employment. To achieve stable prices means the Fed must seek low and stable inflation—a target of 2%. Predictable and low inflation sustains both consumer and investor confidence that the purchasing power of the dollar will retain its value over time. Full employment is the maximum sustainable employment the economy can tolerate, which is difficult to target, and the Fed looks at a variety of factors that can affect employment, but a growing economy needs productive workers.
This “dual mandate” emerged from Congress in the Federal Reserve Reform Act of 1977 and the Humphrey-Hawkins Act of 1978. Unlike commercial banks, the Fed is not a profit-seeking firm, and any earnings it makes belong to the U.S. Treasury. The Fed has three primary governing bodies: the Board of Governors, the Federal Reserve District Banks, and the Federal Open Market Committee (FOMC). The Board of Governors is composed of seven members, the chair of which is appointed by the president to serve a four-year term. There are 12 Federal Reserve District Banks, which have 25 regional branches across the country. These banks provide banking services for commercial banks, not private citizens or corporations.
Strategies for achieving Fed goals are put into action through the FOMC, by which the Fed determines monetary policy through the purchases and sales of government financial assets, such as bonds, known as “open market operations.” This is the primary tool used by the Fed for controlling the money supply.
There are several problems with all this. First, while economists at the Fed should be experts in monetary policy, that doesn’t mean they know exactly what levers to push or that they’re able to move the economy in the direction they desire. We can’t be technocrats with monetary policy any more than we can with fiscal policy. Second, the Fed has become increasingly politicized, which violates the spirit and function of an independent central bank. Economist Alex Salter has called out a Fed that has continually pursued unorthodox practices that became increasingly permissible during the Great Recession of 2008 and even more so during the COVID-19 pandemic. Economist James D. Gwartney et al. explain in their book Macroeconomics: Private and Public Choice that for six decades following World War II, the Fed bought only U.S. government securities through its open market operations. That all changed in 2007; since then, the Fed
has been buying and selling a broader range of financial assets, including corporate bonds, commercial paper, and mortgage-backed securities. If the Fed wants to expand the money supply, it simply purchases more of these financial assets. It pays for them merely by writing a check to itself…. When the Fed buys things, it injects “new money” into the economy in the form of additional currency in circulation and deposits with commercial banks. In essence, the Fed creates money out of nothing.
Desperate times call for desperate measures, and any good politician knows that you never waste a crisis when it presents a real opportunity for the expansion of power. However, these new and unorthodox measures taken by the Fed polarize it. Salter explains:
The Fed revived many of its programs from the financial crisis, such as nontraditional asset purchases. But it’s also doing some truly novel things. These include direct loans to small- and medium-sized businesses, as well as to municipal and state governments. Taken collectively, these actions further push the Fed away from traditional monetary policy. This is dangerous for two reasons. First, there’s no reason to think the Fed is particularly good at making loans. It’s not a profit-seeking entity, after all. (Whatever profits the Fed makes, it remits to the Treasury.) If the Fed loses money on its loans, taxpayers will be stuck holding the bag. Second, although many of the Fed’s new activities were authorized by Congress under the CARES Act, there are serious political risks to these activities. Simply put, the Fed is now engaged in fiscal policy, not monetary policy. And fiscal policy is Congress’s job. By passing the buck, Congress has expanded the Fed’s mandate to a worrying degree. Because the Fed is now directly allocating credit, Congress may try to increase its control over the Fed, using economic means to achieve political ends.
Adding insult to injury, in 2020 the Fed rewrote its statement on long-run goals to include language regarding “inclusivity” for long-term employment. Economist Thomas Hogan rightly points out, and the Fed admits, that these goals are impossible to measure.
Moreover, the Fed currently has almost $9 trillion in assets, more than a little pocket change, and this is up from $1 trillion in 2004. This provides opportunities to wield great power. Additionally, the Fed has bought into the “Environmental, Social, and Corporate Governance” (ESG) narrative and is directing its energies toward “combatting” climate change and pursuing “social justice.” A politicized Fed follows the trending political headwinds and responds to temporary pressures rather than remaining committed to long-standing principles of sound monetary policy. Some have argued that the Fed should only have one mandate, such as a rule-based inflation target. Milton Friedman rings in our ears as he whispers, “I told you so.”
The inflation levels experienced by Americans over the past two years are at 40-year highs. Inflation is a punitive tax on liquidity, or cash holdings. It harms the lowest-income earners the most and subordinates the worst off to impossible tradeoffs, including whether to put food on the table each week. These inflation rates beg for solutions, and so we find ourselves in a cat-and-mouse game whereby we seek a “fix” that nevertheless remains elusive. Moreover, this is all complicated by our drunken sailor, spend-happy fiscal policy, and the collapse of production during the COVID pandemic.
It’s always important to take your principles with you to a policy debate. Here are some of those principles: an independent central bank is necessary; monetary policy should focus on the money supply and not veer into fiscal policy, which focuses on budget expenditures, tax rates, etc.; a healthy and growing economy is fueled by an opportunity-rich society; and predictable and transparent monetary policy fosters long-run investment and entrepreneurship. As Lord Acton warned, “Power tends to corrupt, and absolute power corrupts absolutely.” The more power the Fed gets, the more it will be corrupted by politics and the culture wars themselves. A return to independence and rules over discretion are the solutions we need.
