Does the Federal Reserve Have Too Much Power?
Photo by Andrew Harrer/Bloomberg via Getty Images.
Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Here is Monday’s query:
Name: Lon Jones
Question: My wife and I have enjoyed your economic parts of the NewsHour for a long time. Keep it up. I have recently become acquainted with a group proposing a change in monetary policy based on the writings of Stephen Zarlenga — (monetary.org). They argue that the government should print the money, not the Fed or any other private body. H.R. 2990 proposed by Dennis Kucinich is based on these ideas.
Are they reasonable to you? When and why did we shift to our current system if colonial America thrived on government-originated money?
Paul Solman: First, a technicality. The Treasury does print (and coin) America’s money — our currency, that is. The Federal Reserve creates — this should not come as a shock — federal reserves, which it electronically deposits in financial institutions when it buys bonds they hold. At the moment, the amount of reserves is almost double the amount of currency, due to the Fed’s rescue and bolstering of the banking system, but before the crash, there was more currency than reserves, meaning more “Treasury” money than “Fed” money out there.
Another technicality. As the Treasury borrows more and more money by issuing bonds and selling them to all comers, it commits itself, “with the full faith and credit” of the United States, to pay back its creditors in full. That means it will either raise taxes in the future or — and this is the relevant point — get the Fed to create more money by purchasing bonds on the open market. This is called “monetizing the debt” and it’s the outcome I’d bet on.
On to your question: Is it “reasonable” for the Treasury to create all the money, I guess you mean, instead of the Federal Reserve playing such a major role? My answer: maybe. There’s a legitimate case that the Fed has too much power, is insufficiently beholden to the people in what’s supposed to be a democracy, since no one on the Fed is chosen by popular election and private bankers are heavily represented on its board.
Indeed, this has long been the argument of financial journalist William Greider, author of a major book on the Fed, “The Secrets of the Temple.” I interviewed him a few years ago and he’s still worth quoting. I’d asked if we weren’t better off as a country with the Fed insulated from political pressure and the short-term desires of various constituencies.
“It’s a very comforting argument for those who essentially think democracy works from the top down and all of these children down here have to be regulated by somebody powerful. I don’t feel that about the country obviously but if that’s the case why does this same Federal Reserve argue for letting the financial markets free of government supervision, which is what the Fed did over 20 years?”
I interjected: “But that’s not what the Fed says anymore. Now the Fed says: ‘We want regulatory control. We did make a mistake.'”
Greider: “The idea of giving the Federal Reserve still greater power over the top of the financial system is, I think, a dangerous idea. First of all it rewards failure and you’re acknowledging the Fed failed in many of these functions. But secondly, it puts them in the position as arbiter of who shall fail and who shall succeed and it asks to be able to choose what are the 30 or 40 or 50 banks and industrial firms that it regards as systemic risks for the society and in the event, no matter what it says in advance, it will protect those from failure. And the financial markets, investors, everybody else will understand they’re in the club, and the government stands behind them and the rest of us are on our own.”
Now this is all perfectly reasonable. But I’m not sure I don’t find the current independent Fed alternative more reasonable than a more populist monetary system. Here’s an economist I greatly respect, Princeton’s Alan Blinder, who served as Fed Vice Chairman in the mid-1990s.
“Isn’t the Fed unaccountable?” I asked him a few years ago.
Blinder: “It’s accountable to Congress; they have to explain themselves to Congress. They should. It’s a creature of Congress, and this is a democracy. The Congress could change the Federal Reserve Act tomorrow if it saw fit. So it is accountable in that sense but it’s very important if the Fed is going to do some of the ‘nasty’ work that it sometimes has to do, to fight inflation — that the Fed has a lot of independence and there’s reams of evidence by now that Central Bank independence does a country a lot of good. You get better economic performance. It’s not an accident that country after country in the world has moved to the German-U.S. model. The Bundesbank and the Fed were independent before just about all the other Central Banks and now almost the whole world has moved in that direction. And I don’t think it’s because of a revulsion against democracy. I think it’s because of perceived success that it’s a better way to run monetary policy than let politicians run it.”
And there you have it: the essence of the debate about the Fed. But rest assured — or perhaps it would be more accurate to say, rest uneasy. No matter who creates money, there will be howls of protest when the economy malfunctions. Too much money causes inflation, which reduces the dollar’s value. That benefits debtors, because they owe dollars. They can now pay back with cheaper money. Creditors, obviously, get less, in real terms, than they counted on. By contrast, a “hawkish” monetary authority that creates too little money preserves the value of the dollar and is then blamed for favoring the lenders over the borrowers.
Pick your poison.
This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions