The celebrated investor Jim Rogers thinks we should abolish the Federal Reserve. Asked in an interview yesterday what he’d do as Fed chairman, he replied: “I’d shut it down.”
Rogers is a long-time critic of the central bank, and so his view is old news. He also has lots of company. Perhaps the most prominent and powerful critic is Rep. Ron Paul, head of the House subcommittee that oversees the Fed and author of End the Fed.
Attacking the Fed is an old sport, dating to the bank’s founding in 1913. Inspiring the legion of critics over the years is the simple fact that the central bank is far from perfect. As an institution run by humans, policy errors are inevitable. But closing the Fed, for all its populist appeal these days, wouldn’t solve much, if anything because something would need to take its place. Wouldn’t a successor institution suffer from all the problems that bedevil the Fed? What’s that? You have a solution to insure the delivery of superior monetary policy decisions? Really? Why don’t we apply those cures to the Fed?
The hard reality is that a modern economy needs a central bank. Some institution has to oversee monetary policy, unless we’re going to go back to bartering. Letting Congress assume these duties is asking for trouble. The Fed is far from immune from political influence, but imagine how monetary policy would be run via debates on the floor of the House of Representatives.
Some Fed critics like to argue for a return to the U.S. to a gold standard. That’s unlikely for a number of reasons. But let’s say the impossible happens. Even on a gold standard, a central bank is necessary to supervise the details and insure that the rules of the game are satisfied. Of course, one could argue that the country could return to the pre-Fed-era banking chaos of the late-19th century, but that’s the monetary equivalent of advocating the use of horses as a solution to the traffic problems created by cars.
The irony in all the recent calls to end the Fed is that inflation is quite low by historical standards. Paul and others worry that the Fed’s quantitative easing policy will soon unleash higher inflation. That’s always a concern, and the solution is, as always, enlightened decisions on monetary policy. Unwinding QE2 doesn’t have to bring higher inflation. It might, of course, but that’s hardly a reason to shut down the Fed. By that standard, we should close the Pentagon because it might make a mistake in the next war.
Meantime, some Fed critics point to rising commodity prices as a harbinger of things to come. Rising oil prices in particular raise fears of future inflation in the hearts and minds of many Fed bashers. Maybe, although as Bloomberg’s Caroline Baum points out, higher prices and inflation aren’t always one and the same:
For folks who use the term “inflation” interchangeably with higher prices — as in wage inflation or commodity inflation –they are not the same thing. A higher price for oil and/or other commodities is a higher relative price until ratified by the central bank.
What does the central bank have to do with it?
Inflation is a monetary phenomenon: too much money chasing too few goods and services…
Higher oil prices don’t cause inflation. They aren’t synonymous with inflation. Higher oil prices represent a relative price increase until proven differently.
None of this is an argument for giving the Fed a free hand. Debates about how the central bank—any central bank—conducts monetary policy are always fair game. There’s certainly room for improvement; the past decade has revealed quite a few lessons about how to run monetary policy. But that’s quite a different animal from calling for the institution’s demise.
It’s easy to say the Fed’s makes mistakes and therefore it should be closed. But what’s the follow-up plan? Will you create a new institution to run monetary policy? Are you willing to give Congress that power? The critics don’t usually have good answers to such questions. No wonder that it’s hard to take the kill-the-Federal Reserve-system crowd seriously.