Joseph Sternberg, author of the โPolitical Economicsโ column at the Wall Street Journal, has been on the Federal Reserveโs case recently. He continues to take central bankers to task in his latest article. โThe next president will inherit a Federal Reserve staffed by economists โ and their intellectual helpmates in academia โ who still donโt fully understand what has happened over the past few years, let alone over the past few decades,โ Sternberg warns. Heโs right. Fed officials admit to only limited and contingent culpability for high inflation in recent years.
The Fed is a flawed institution at best, and a failed institution at worst. Sternberg suggests several reforms. While potentially helpful, none go far enough.
First, Sternberg castigates the fashionable yet unfounded belief amongst policy economists that โMr. Trumpโs economic agenda of tariffs and tax cuts would be inflationary.โ Sternberg is right to call out this nonsense.
Tariffs would make specific goods and services more expensive. This is a relative price effect. It only shows up in the general price level if it affects enough prices to drive up the indexโand even then it doesnโt really qualify as inflation, because itโs a one-time transition to a higher price level. Inflation means a higher growth rate for the price level.
Tax cuts arenโt inflationary, either. If anything, by incentivizing additional savings and investment, tax cuts may result in a small productivity boost, and hence mild disinflation. The crude Keynesianism Sternberg calls out, despite its consistent record of failed predictions going back more than 70 years, is still alive and well amongst economists who see themselves as efficiency engineers first and social scientists second. We can safely ignore them.
Next, Sternberg laments Fed decision-makersโ โgroupthink,โ explained in part by the concentration of authority in the โWashington-based Board of Governors in thrall to the central bankโs research department.โ The โFedโs independence from the rest of the governmentโ amplifies its irresponsibility. It โmeans politicians and voters canโt enforce accountability.โ Sternberg correctly highlights the Fedโs adoption of flexible average inflation targeting (FAIT) in August 2020 as an example of deep institutional flaws. The Fed is picking its own goals and deciding whether or not it has achieved them. In other words, itโs a judge in its own cause. Thatโs unacceptable for anyone who cares about the rule of law.
How to fix this? Sternberg suggests changing how the Fed makes decisions, so that regional Fed branches have more input. He also wants Congress to keep a closer eye on monetary policymakers. These are probably good ideas. At the margin, they would help. But we can and should do more.
Here are a few harder-hitting ideas for Fed reform:
- Get rid of the dual mandate. Itโs redundant. The Fedโs monetary policy activities should solely focus on price stability.
- Pare back the Fedโs regulatory powers radically. The Fed should ensure banks are adequately capitalized against short-term liabilities. Thatโs it.
- End further credit allocation. Close the discount window.
- Shrink the balance sheet. Return to a โTreasuries onlyโ policy for open market operations.
- Stop paying interest on reserves. Ditch the floor system and return to the corridor system.
For even more radical (and effective) reforms, consider the following, in ascending order of implausibility:
- Compel the Fed to stabilize the dollar, or current-dollar GDP, or a related nominal anchor. If central bankers fail, they get fired.
- Eliminate the FOMC. Automatically grow the monetary base by a set percentage each year. Long live Milton Friedman!
- Freeze the monetary base. Outsource monetary policy to the market. From now on, financial intermediation (banking) is the sole means by which the money supply changes. The only requirement is banks must redeem their liabilities for fiat dollars, the stock of which is now fixed.
- Revive commodity money. The gold standard is massively underrated. Itโs not as attractive an option if the US is the only economy on gold. But itโs still worth a look.
โFed reform could be the nerdiest sleeper issue of this campaign season,โ Sternberg concludes.
I can only wish. Americans are hopping mad about dollar depreciation. But even with 9-percent consumer price inflation during 2022, Congress never seriously considered changing how the Fed works. Nevertheless, it should. I hope Sternberg is right about citizensโ appetite for reining in the central bank โ the hungrier, and nerdier, the better.
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