Monday, January 11, 2010

Arguing About Monetary Policy

What do you know? Economist John B. Taylor is in a spat with Federal Reserve Chairman Ben Bernanke about monetary policy.

Taylor is the author of a rule that specifies the interest rate that the Fed ought to use to guide its monetary policy. According to the Taylor Rule, the Fed's policy was too loose in 2002-2005. Helicopter Ben gave a speech explaining, as Taylor writes in the Wall Street Journal, that things were OK after all:

In his speech, Mr. Bernanke's main response to this critique was to propose alternatives to the standard Taylor rule—and then to use the alternatives to rationalize the Fed's policy in 2002-2005.

Well maybe Ben has a point. Or maybe not. Id be a lot happier if the Fed chairman were a real banker, and the Fed were a completely private organization that didn't owe a dime to the government.

The fact is that ever since 1913 the Federal Reserve has been an obvious stooge of the US government. You can say that, in wartime, that's the right stance. But in peacetime the Fed spends far too much time pulling the politicians' chestnuts out of the fire. The result has been that the dollar has declined in a single century from $20.75 per ounce of gold to $1,100. It's worked out real good for the nation's biggest debtor, Uncle Fed, but not so good for widows and orphans.

The big problem with the Fed is that it is always trying to rush recovery from recessions, as right now. In doing so, no matter what the rules it tries to follow, it always delays too long the change from stimulative policy (printing money) to a restrictive policy.

What we need to do is take the Fed out of the policy mix for stimulating the economy. It should maintain the value of the dollar at a fixed gold price (or other price if it can find a better one) and stand by to rescue the credit system if it seizes up.

Of course, even if it did this one small thing, it still wouldn't solve the Fannie Freddie problem. But at least it's a start.

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