Too Big For Its Britches?

The Federal Reserve system was created under Wilson in 1913. Originally tasked with protecting the value of the currency its mandate was expanded in the 70's when the Federal Reserve Act was amended to promote the goals of, “maximum employment, stable prices, and moderate long-term interest rates,” (Section 2A).

“Stable prices,” means protecting the value of the $. The Fed is armed to do this by expanding or contracting the supply of $’s available - too many and they are worth less, too few and they are worth too much.

“Moderate long-term interest rates,” are not something the Fed controls very well, if at all. “Maximum employment,” are the two words however that can get the Fed in a lot of trouble.

At the moment critics claim that through the pursuit of this “maximum employment” mandate the Fed has been reduced to an extension of the administration, that is, Bernanke more the politician than the central banker.

We’ve all heard of QE2. This means that the Fed is buying practically everything under the sun in an attempt to quick start a recovery. The idea is to get medium-to-longer term rates lower, the dollar just a tad weaker in order to spur exports, all of this with employment in mind. This is not equivalent to addressing a crisis, to preventing a melt down. (Without the Fed’s emergency action Q4 ‘08, we’d all be paupers.) No, it is a completely discretionary, non rule-based activity and a mistake, one which first will have little to no impact on the pace of recovery and two, is corrosive to Fed independence, a necessary item, the heart of monetary control.

It is this trend at the Fed toward discretionary actions that is alarming to so many and who see this, correctly we believe, as just an attempt to bail out BO’s failed fiscal policy.

A group of 23 economists, money managers and former government officials issued an open letter to Bernanke on Nov. 15 saying the central bank’s planned bond purchases “risk currency debasement and inflation” and won’t boost employment.

Another critic is Fed governor Kevin Warsh, who noted recently that, "The Federal Reserve is not a repair shop for broken fiscal, trade, or regulatory policies.”

Apparently, Bernanke is not listening. We need only recall Hayek’s “Fatal Conceit” to know that a few individuals, no matter how gifted cannot replace in their judgement the complexities of a free functioning market. This applies to the FOMC as well as to Obama’s wanna-be planners.

We have followed the Fed closely for 20 years; never has it come so close to shedding its independence. Let us hope the new Congress re-writes the Fed’s mandate to confine its activities only to those of price stability.

Robert Craven