Against the Fed

One of the most bizarre things about the economics profession is how much the Federal Reserve is simply taken for granted in the US economy. The ostensible purpose for its creation in the wake of several financial panics was to stabilize the economy. Its track record on that account has not been very good. As I understand it, what stabilization there has been can largely be attributed to other factors, particularly globalization and the maturation/diversification of the US economy. (If you have four sectors and one goes under, you’re hurting. If you have forty and one goes under, it’s not as bad.)

Most economists are of the mind that the Fed can be a useful tool for certain stabilizing purposes, and in any one-off investigation that may be the case. However, on net it seems like a bad bargain to me. The history of central banking worldwide has been one of special interests, favoritism, unfree markets, and government overreach. The Fed continues this inglorious tradition.

The interest rate* is a price. We know that government price-fixing is a fool’s errand in other areas, but in this one somehow they get a pass. Having one central agency determine what the interest rate will be cannot possibly be as efficient as the alternative. How does the Fed know what it should be?

Beyond the Keynesian framework that dominates the economics profession right now, which gives a large role to government policy makers, I suspect the other main reason for widespread support for the Fed is simply that it has existed for a long time. Most economists, like most people, are not very creative. They tend to think of tweaks for systems rather than alternative systems. On top of this, groups with a vested interest in the system as it currently is have a big incentive to shame creative heterodox ideas. These three reasons make it that much more difficult for a real ideological challenge to the Federal Reserve System to circulate widely.

* There is not actually one simple interest rate, but for the purposes of this discussion we can gloss over that.


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