The Queen of England recently heard from her nation?s economic experts, who wrote to apologise for their profession?s inability to predict the financial crisis. It?s different in the US Here, economists don?t apologise to the throne. They sit on it.
The throne in the US is the post of chairman at the Federal Reserve. As currently configured, this office is more powerful than Elizabeth II?s, with almost unlimited discretionary authority to intervene in the world economy.
The Fed was created in 1913. Lawmakers strengthened its powers in the 1930s and then again after World War II by effectively charging it with watching over not only money but economic growth generally. Until 1971, there existed a mechanism that served as a check on the Fed?s discretion, at least theoretically. It was the gold standard. If the Fed created too much money, capital went abroad to less inflationary venues. That in turn forced the economy to contract. Central bankers controlled money creation because they didn?t want to be blamed for a recession.
President Richard Nixon broke that mechanism when he took the country off the gold exchange standard in August 1971. Since then, the economy has been in the hands of the king?the Fed chairman?and his counts and barons, the members of the Federal Open Market Committee. The record suggests that they aren?t deserving of royal status.
Central bankers always argued that there was a tradeoff between unemployment and inflation: the country had to pick one of the two poisons. Then the 1970s brought both poisons ?joblessness with inflation. Former Fed chairman Alan Greenspan, current chairman Ben Bernanke and many of their colleagues all failed to predict the current crisis. Worse, they may have helped cause it by keeping interest rates too low this decade.
Why did the Fed keep rates low? We can guess that the events of September 11, 2001, and the start of the Iraq War in 2003 are part of the answer. The US didn?t want economic trouble at home while it was fighting abroad. What?s clear is that rates were kept low in part for an arbitrary reason: because Greenspan, then Bernanke, felt like keeping them there. In 2002, when Bernanke was still a mere count in the Fed court, he spoke at an event honouring his fellow economist, Milton Friedman. Bernanke recited the errors of the Depression- era monetary authorities: they forced an epic deflation and banking credit crisis on Americans. Bernanke then promised that he and his Fed colleagues ?won?t do it again?.
Then Bernanke, as chairman, said the current crisis might already be worse than the Great Depression. In other words, the Fed policy of the current decade has worked insufficiently, or hasn?t worked, or has made matters worse. Yet the more trouble their arbitrary policy causes, the more ennobled our central bankers seem. Washington has the power to end this monarchy. It can replace economists with economics ?rules-based mechanisms that automatically curtail Fed discretion. One such experiment could involve the Taylor Rule, which says the Fed should aim to set short-term interest rates following a formula that measures inflation, employment and the pattern of interest rates. Had the Fed followed the Taylor Rule, it wouldn?t have loosened rates as much as it did, which may have slowed the housing boom.
The trouble is not Bernanke or Greenspan or even their respective courts. The trouble is that the throne exists in the first place.
?Bloomberg