Jeff Deist recently published an editorial in the Washington Times challenging various proposals—popular among DC think tanks—to create monetary policy “rules” or targets based on statistical data related to inflation or GDP.
Some highlights:
One hopes Mr. Powell sticks to his guns and his earlier commitment to tightening in the face of bad economic news. He certainly will face pressure, and not only from President Trump and Congress. Nearly the entire think-tank chorus sounds alike when it comes to monetary policy: The Brookings Institution, the American Enterprise Institute, the Heritage Foundation, the Mercatus Center, and the Cato Institute all offer up some version of rules-based policy.
Rules are meant to be broken. Rules-based proposals are relatively complex and not particularly suited to winning over Congress. It’s one thing to legislate a broad dual mandate for the Fed and hope for the best. It’s another to reach bipartisan agreement on the Taylor Rule and mandate its execution by law. Rules-based proposals are likely to become internalized Fed policies at most, not laws.
But as we’ve seen, policy rules tend to go out the window in times of economic crisis. Fed chairs do not serve in a vacuum; politics and current events often lay waste to the Fed’s vaunted independence. Only Paul Volcker and William McChesney Martin seemed to have resisted the bidding of unhappy presidents.
Monetary rules don’t truly get at the heart of things. Technical analysis and mathematical formulas only obscure the complexity and human fallibility of the real world. Mr. Powell and company are tasked with determining the “best” monetary policy for 320 million Americans with widely diverse interests.
The answer to our coming economic woes lies in recognizing that no monetary policy tinkering can replace the fundamental corrections that must take place: bankruptcy, liquidation and restructuring of firms to clear out bad debt; higher interest rates to encourage capital formation and discourage more malinvestment; an end to direct bailouts by Congress and roundabout bailouts by the Fed; and a serious program of spending and debt reduction in Washington that spares neither entitlements nor defense.
As the article makes clear, statistical or mathematical analysis of economic data cannot save Fed officials from their insurmountable task: determining the supply and price of money in a vast economy. As Ludwig von Mises explained more than a century ago in The Theory of Money and Credit, money is a marketplace phenomenon; as such it cannot be engineered through any amount of technical monetary or fiscal policies:
All proposals that aim to do away with the consequences of perverse economic and financial policy, merely by reforming the monetary and banking system, are fundamentally misconceived. Money is nothing but a medium of exchange and it completely fulfills its function when the exchange of goods and services is carried on more easily with its help than would be possible by means of barter. Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression. Recurring economic crises are nothing but the consequence of attempts, despite all the teachings of experience and all the warnings of the economists, to stimulate economic activity by means of additional credit.
We can’t “reform” the Federal Reserve Bank any more than we can reform the FDA or IRS or TSA. Politics and the economic calculation problem cannot be overcome by tinkering.
