FED Independence
An article in the WSJ by Ron Paul and Jim DeMint today discusses the issues of FED independence and transparency. They mention a "puzzling assertion made by the Fed and its supporters ... that the Federal Reserve has some sort of independence from the government." They continue to argue that the FED is not independent, but instead is a government run monopoly whose mandate to maintain stable prices has caused them to expand the money supply thereby causing an inflationary effect rather than, what they claim to be, the natural deflationary tendency caused by ever rising productivity. Indeed in their first paragraph they mention that in the past 96 years the US dollar has lost 95% of its purchasing power.
OK, but here's what they haven't mentioned. First, one problem with deflation, especially if it's persistent, is that it can slow down the growth of economies. The reason is that expectations that prices will soon fall will make consumers and businesses hold off on purchases waiting until they can get the better deal. Anyone buying a computer in the past few decades knows how frustrating it can be to buy when you know that in 6 months the same expenditure will get you a faster computer with more features. Thus deflation can reduce the velocity of money, or the rate at which transactions are made. For this reason it makes some sense to maintain a low and steady inflation rate.
The second thing they fail to mention is the experience of many other countries that did not have semi-independent central banks. The problem that often arises is that legislatures are pressured to raise government spending and programs, thereby pleasing voters, but are reluctant to increase taxes to pay for these programs, which will clearly displease voters. Borrowing to finance a government deficit is always the next option, but sometimes this can be expensive especially if the government is running up large and potentially unsustainable deficits forcing them to raise interest rates to a high level to attract lenders. (currently the US has the large deficits, but not yet the very high interest rates). The other option, which seems relatively painless, is to force the central bank to "lend" the government the money it needs to finance its large deficit. Of course, central bank lending also means the printing of money, which if not counteracted by a drop in money elsewhere, is certain to have inflationary consequences.
Studies in the past have suggested that countries who have had severe hyperinflations in the past (e.g. Latin American countries in the 70s and 80s) are also those whose central bank was NOT semi-independent from its legislature. However, the countries whose central banks are more independent, like the US, have had a much lower inflationary path.
Thus, there are some good reasons to maintain FED independence that have been overlooked in this article. That's my main point!
1 comments:
'The adjustment process in the financial market under a gold standard will work through changes in interest rates. When the US money supply rises after the gold discovery, average interest rates will begin to fall. Lower US interest rates will make British assets temporarily more attractive and US investors will seek to move investments to the UK. The adjustment under a gold standard is the same as with goods. Investors trade dollars for gold in the US and move that gold to the UK where it is exchanged for pounds and used to purchase UK assets. Thus, the US money supply will begin to fall causing an increase in US interest rates, while the UK money supply rises leading to a decrease in UK interest rates. The interest rates will move together until interest rate parity again holds.'
Sorry if it is a little off topic for this post. I find it surprising that the 'interest rate mechanism' isn't more widely known and studied. If capital is mobile, interest rate parity must hold, and any increase in gold must be distributed to the world's gold reserves (e.g. bank reserves) without delay, and therefore the impact must be the same throughout the world, and the 'price-specie flow mechanism' is redundant.
Further appreciation of this 'interest rate mechanism' implies that the interest rate has a negative relationship with the gold stock under a gold standard. This relationship is implied by White's bank profit maximisation model (Ch 1 of Free banking in Britain), but does not appear to be recognised, even by White himself (as far as I can tell).
I would be interested in hearing from you more about the 'interest rate mechanism' e.g. who developed it, when, and whether it has been developed as I have suggested to make the 'price specie-flow mechanism' redundant, and to imply a negative relationship between the interest rate and the gold stock. Note: I have developed an alternative macroeconomic model based on this approach, and I am researching whether it is new or whether the assumptions it is based on have been elsewhere developed. Thanks.
Post a Comment