There’s No Going Back

When I was young I thought I was experiencing a series of events.   Now I understand that I was experiencing the feeling of being young.  Sure you can go back and revisited a bunch of European countries, but it won’t seen the same as when you first tramped around Europe with a backpack, and the world seemed charged with mystery and meaning.

I think of public policy in similar terms.  Obviously there are cases where we can literally go back—the 21st Amendment restored the status quo ante of before the 18th Amendment.  But it’s never quite the same.  Indeed in just the last 10 years we’ve lost the ability to drink alcohol at our Bentley holiday party (I suppose due to fear of lawsuits.)

How I think about the past often depends on whether my mood is that of an ornery reactionary or a hopeful progressive.  Whether listening to talk radio or NPR.  Sometimes I think both the left and right miss something important when they visualize the past.  The right tends to romanticize a golden age that was ruined by statism, whereas the left sees a period of misery, which progressive legislation has lifted us above.  I believe the right has lots of blind spots, and the left often attributes change to legislation that actually reflects the fact that we are vastly richer than 100 years ago.

As a macroeconomist I often think of the spring of 1929 as a sort of golden age of policy, when there didn’t seem to be any significant macro problems and we had a pretty efficient policy regime.  But how should a pragmatic libertarian like me think about 1929 vs. today?  It’s not quite as obvious as you might think.  In some ways things have certainly got worse; Federal spending has grown from 3% to over 20% of GDP.  We have an alphabet soup of regulatory agencies that do more harm than good.  But there are also many changes for the better.  The rights of blacks, women, and gays are much better protected than in 1929.  And even many of the changes that would be vigorously opposed by more dogmatic libertarians, are somewhat ambiguous to a pragmatist like me:

1. Social Security and Medicare really do help older people, but the systems were set up in a way that discourages saving.
2. Some environmental regulations really do improve our lives, but they are often implemented in an inefficient way.
3. We have lower tariffs, but many more non-tariff barriers.
4. We’ve gained the right to drink alcohol, but also suffer from a new reign of paternalism
5. We are more willing to tolerate immigration from non-European countries, but must suffer under the abominable TSA and INS.
6. There is less regulation of transport pricing and entry, but more rent controls and minimum wages
7. We have unlimited bank branching, but much more moral hazard in the system.
8. There is more annoying paperwork today, but also less governmental corruption

I suppose for a dogmatic libertarian things are clearly worse, but for a pragmatist like me that’s not so clear.  Which finally brings me to monetary policy.  Are we better off today than in 1929?  How about compared to 1912?  I pick those dates because our monetary system has undergone two revolutionary changes in the past century; we’ve added a central bank and dropped the gold standard.  There’s only one thing I am really sure of; it’s a really, really bad idea to have both a central bank and a gold standard.  If you don’t believe me, check out the macro performance of the US between 1913 and 1941.  Both inflation and output were extraordinarily unstable.

In my view we are better off without the gold standard.  We can’t afford to leave the price level and NGDP to chance, where an increase in the demand for gold could cause severe deflation and depression.  Admittedly the worst example of this occurred under a gold standard that was far from pure (1929-33) but there are two strong arguments that cut the other way:

1. The gold standard was also far from pure during the so-called classical period (up to 1914.)
2. The whole point of the gold standard is that it’s supposed to work automatically, to protect you against foolish governmental decisions—indeed to prevent governments from printing too much or too little money.  If we need sensible government to make the gold standard work, then why not just attach the sensible government to a fiat regime, that will work even better (and did between 1983-2007.)

So far I’ve been emphasizing my progressive side, but now I’m going to do a 180 degree pivot.  I think a very strong case can be made that we’d be better off if the Fed had never been created.  Indeed a recent paper by George Selgin, William D. Lastrapes, and Lawrence H. White makes exactly that case.  It’s a very long paper and it marshals an impressive array of evidence against the Fed.  The focus in on two areas; whether the Fed has actually made the economy more stable (unlikely), and the effects of its regulatory actions,particularly in the recent crisis.  As far as I am concerned, their new paper becomes the definitive critique of the Federal Reserve System, which any academic researching the issue will have to address.

If you are a pragmatist like me, don’t write off the paper as a hopelessly utopian attempt to re-create a mythical gold age.  Their arguments are much more subtle and nuanced:

“Coming up with alternatives to the Fed today takes more imagination. Assuming that there is no political prospect of replacing the fiat dollar with a return to the gold standard or other commodity money system, for the dollar to retain its value some public institution must keep fiat base money sufficiently scarce. [..] [T]he Fed’s poor record calls for seriously contemplating a genuine change of regime. In particular it strengthens the case for pre-commitment to a policy rule that would constrain the discretionary powers that the Fed has used so ineffectively. Whether implementing such a new regime should be called “ending the Fed” is an unimportant question about labels.”

That’s exactly where I am on the issue.  It’s not a question of going back or staying where we are, it’s about moving forward.  Here’s an analogy.  The left and right have been debating whether we need a government-run postal service for decades.  Long before that debate is resolved technology will have eliminated the need for snail mail (except packages, which can be easily delivered by Fedex or UPS.)  It’s likely that long before we solve the problem of whether to use interest rate or money supply control, we will go to a cashless society with all electronic money.  That will make possible Robert Hall’s (1983) visionary scheme to index interest on reserves in such a way as to automatically stabilize the expected future price level (or NGDP.)  No Fed discretion is required.  Even Woodford once had nice things to say about the idea.

The debate over “ending the Fed” is pointless.  There will always be something called “the Fed.”  What we need to do is not to end it, but emasculate it.  Take away its discretion and simply give it a nominal mandate, and let the market implement the mandate.

I see the human race as like that runaway train in the new Hollywood film.   Technology is hurtling us rapidly toward a future that we can’t envision, and which would both horrify and dazzle us if we could.  (Just as the ancient Greeks would be both horrified and dazzled by our current culture.)  We don’t study the past to try to recreate the past, but rather to learn lessons that we hope will make the ride on this runaway train a bit smoother.

PS.  Thanks to William for sending me the quotation.  I’ll try to have more to say about other issues raised in the Selgin/Lastrapes/White paper when I have more time.  David Beckworth, Tyler Cowen, Alex Tabarrok, Bryan Caplan, and Arnold Kling also make comments.  I agree with some of the points made by Cowen, although I’d point out that while it’s true that if we’d had no Fed in 2008 there might have been a Great Depression, it’s also true that if we had no Fed in 2002 there would have been no sub-prime fiasco.  Banks don’t do that sort of thing without a safety net.  I will be at another conference this weekend, so blogging will again slow to a crawl.

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