Almost all the mainstream discussion of monetary policy in the United States today and for a number of decades is and has been about what kind of monetary policy the Federal Reserve should carry out. Should the Fed target interest rates and, if so, how? For example, should it follow the Taylor Rule, named after Stanford economist and Hoover senior fellow John Taylor? Should the Fed target nominal gross domestic product, as Mercatus Center economist Scott Sumner advocates? Should the Fed give up on inflation and make sure that unemployment doesn’t spike? Should the Fed give up on unemployment and make sure the inflation rate stays low or, given today’s data, decreases to a low rate?
All these questions are worth asking. But notice that these questions are about how the Fed should engage in central planning of the money supply. Few Americans, and even a lower percent of economists, think it’s a good idea for the federal government to centrally plan the number of cars that should be produced in the United States. Economists don’t typically call for the federal government to decide how much steel should be produced. Why, then, do the vast majority of economists think that the Fed should centrally plan the money supply? It must be because monetary policy before the Federal Reserve existed led to much worse results than after the Fed started operating in 1914.
Yet it turns out that we got better results on inflation and roughly equivalent results on business cycles prior to 1914. Moreover, our monetary institutions prior to the Fed had serious deficiencies due to damaging regulation. Without those regulations, monetary policy prior to the Fed would have been even better.
These are the opening 3 paragraphs of David R. Henderson, “The Fed Is a Failed Central Planner,” Defining Ideas, April 1, 2022.
My favorite paragraph:
Many people now say that the Great Depression was an unfortunate learning experience for the Fed. Indeed, at a party at the University of Chicago to belatedly celebrate Milton Friedman’s ninetieth birthday, Ben Bernanke, then a member of the Federal Reserve Board, ’fessed up. He said, “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” But saying that it was a learning experience reminds me of the famous scene in the 1964 movie Dr. Strangelove in which President Muffley, played by Peter Sellers, realizes that one of his generals, Jack D. Ripper (Sterling Hayden), has acted on his own to start a nuclear war with the Soviet Union. Muffley says to General Turgidson (George C. Scott), “General Turgidson, when you instituted the human reliability tests, you assured me there was no possibility of such a thing ever occurring.” Turgidson’s priceless reply: “Well I don’t think it’s quite fair to condemn a whole program because of a single slip up, sir.” The Great Depression was a pretty big slip up.
But even examining the record of the Fed after WWII with the pre-Fed experience doesn’t make a clear case of the Fed on recessions and depressions, as I show.
Read the whole thing.
READER COMMENTS
Matthias
Apr 2 2022 at 8:18pm
I don’t see a mention of Canada in the article?
Comparing the Fed against the silly American system that preceded them is playing softball.
See eg https://www.alt-m.org/2015/07/29/there-was-no-place-like-canada/
Phil H
Apr 2 2022 at 10:22pm
One possible problem with this argument is that it compares, roughly, the 19th century with the 20th century, as though that is comparing like with like. But the 20th century was a period of much higher growth. It’s when the miracle of modernity actually happened. I’m not sure how you’d reweight the argument to take that into account (or even if it’s necessary to), but it seems like a relevant factor that needs some consideration.
Thomas Lee Hutcheson
Apr 3 2022 at 7:37am
So exactly what is the proposal?
Scott Sumner
Apr 3 2022 at 10:41am
To be clear, Bernanke’s claim was something like the following (my words):
Defects in the gold standard caused a Great Depression, and the Fed did not do enough “central planning” to prevent it.
As an aside, I don’t believe the term “central planning” fits what the Fed does. A central planner plans all markets, not just one.
Andrew_FL
Apr 3 2022 at 2:11pm
1. No, that’s completely wrong. If the state owned all the railroads we would say that the state centrally plans the market for rail transportation
2. The market for money literally *is* every other market, in a monetary exchange economy without any barter
Jon Murphy
Apr 3 2022 at 6:59pm
No, that would be a monopoly, or a nationalized industry. “Central planning” is typically reserved for planning the entire economy. I mean, if you want to call a nationalized industry “centrally planned industry,” that’s fine. But it’s an atypical use of the phrase. The Fed may be a central planner (I go back and forth on the idea), but it’s not because they control a single market.
I wouldn’t go that far. Money is indeed important, but to say money = every industry because it is important is not quite correct. We could say that oil is “literally every other market” given its importance.
Besides, in a monetary exchange economy, money can be neutral. Relative prices matter, not relative prices. If all prices doubled tomorrow, then there would be no change in the allocation of resources given that relative prices do not change.
Andrew_FL
Apr 3 2022 at 9:01pm
It is correct usage
Also, do tell me what you can go out and exchange goods and services for besides money
Jon Murphy
Apr 3 2022 at 10:23pm
Again, it’s not. See, for example, Lange, Lerner, or Tinbergen (for the pro), or Hayek, Mises, Boettke (for the con). A quick Google search finds multiple sources defining “centrally planned” as the whole economic system.
But I am willing to change my mind. Make your case.
There are lots of things (I’m currently doing a little work in exchange for books, and many many people have been vey generous with time), but the question of exchange is irrelevant to my point about the neutrality of money.
Andrew_FL
Apr 4 2022 at 9:19am
By your logic if there is even one industry which is not nationalized there is no central planning. Your usage is *obviously* logically wrong.
Jon Murphy
Apr 4 2022 at 12:16pm
Not at all. See Sandy Ikeda’s 1997 book The Dynamics of a Mixed Economy.
Again, I am simply using the term as it has always been used. If you want to change it, fine, but you need to make the case for it.
Andrew_FL
Apr 4 2022 at 5:15pm
I am not going to read an entire book for an argument that some planning is not total planning, and therefore somehow doesn’t count.
It does not matter how a term “has been used” if that usage is logically incoherent.
Jon Murphy
Apr 5 2022 at 8:57am
The point of me citing the literature is that the points you raise have already been asked and answered. If you want to say the argument is incorrect, that’s acceptable, but you need to explain why the answers already given to your questions are insufficient.
True, but there ought to be a presumption of status quo here. Given that this has been the how the term has been used for almost 200 years now, including when studied at the highest levels of academia, I think the likelihood of it being “logically incoherent” is quite low.
I’ll given an example: as inflation has persisted, I get comments all the time on Facebook or from students outside my econ classes along the lines of “How can prices be rising if corporations are earning record profits? Prices cannot be driven by costs, therefore economics is logically incoherent.” Of course, economics shows that there are many ways prices can change. These folks are just largely unaware of the literature on price theory. The questions they ask have already been answered.
Of course, you may be right. People have indeed shown inconsistencies in thoughts much older than the debate between central planning and liberalism. For example, John Snow who overturned thousands of years of medical understanding because he ultimately figured out the miasma theory isn’t consistent. But a lot of evidence was needed.
Scholars are not always right. Indeed, I’d say on almost any given thing it’s about 50-50 (the Replication Crisis has undermined a lot of seemingly “proven” things). But you need evidence.
David Henderson
Apr 4 2022 at 3:41pm
You wrote:
I’m not sure you’re right. If I had said that the Fed is a central planner of the economy, then you would have had a good point because that’s clearly not true. But I said that the Fed is a central planner of the money supply.
Don Geddis
Apr 3 2022 at 8:56pm
It appears as though you’re advocating to End The Fed. (“Wouldn’t it be nice if economists … challenged the whole idea of central planning?“) But you offer very little support for what a better system might be.
Before the Fed, the economy had many (unnecessary) problems. It is also true that the Fed has made many (major!) mistakes over the last century — including the 1930’s Great Depression, the 1970’s Stagflation, and the 2008 Great Recession.
But shouldn’t the goal be to understand what is important in a monetary framework, and deliberately and consciously choose the best structure? For example, you complain that inflation was higher after the Fed, than before. But the Fed has deliberately targeted 2% positive annual inflation for decades. If that’s an error, then you should argue for it directly, and by far the simpler fix would be to simply have the Fed target 0% instead of 2%. They don’t do that, not because of “central planning”, but instead because they believe it’s better for the economy.
Scott Sumner has tried to outline a path forward, that would be better than both the pre-Fed economy, and also the last century of the Fed. Level (not growth) targeting of nominal (not real) GDP (not inflation). NGDPLT shows promise (based on macroeconomic theory) of offering superior performance to all of the historical examples that you list. If you want to criticize the Fed, don’t you think it’s important to argue that you have a better idea to replace it with?
Jon Murphy
Apr 3 2022 at 10:24pm
I don’t understand your point here. Your statement (indeed, the entire paragraph) is a central planning point.
Don Geddis
Apr 3 2022 at 11:17pm
The point is that “central planning” allows for 2% inflation — but inflation isn’t a consequence of “central planning”. Having a fiat currency central bank merely allows us to choose the monetary path of the economy. Some structures are better for the economy than others. Any other monetary structure (e.g. a gold standard) would also be some particular monetary path — one that a central bank could trivially emulate.
Fiat currency central banks merely allow more choices to be made. The point should be to do the careful analysis and select the best choice. It’s missing the point to argue about “the Fed” vs. “not the Fed”. The discussion should instead be about: what path for the money supply results in the best performing economy? After we agree on the best path, then we can set up an organizational structure which implements that ideal policy.
Arguing about specific real-world organizations, when you don’t have agreement on optimal monetary policy, seems to be totally beside the point.
Jon Murphy
Apr 4 2022 at 6:45am
I’m sorry I’m not seeing the distinction here. If the goal of a central planner is 2% inflation, how is the resulting 2% inflation not due to the central planning?
Don Geddis
Apr 4 2022 at 11:34am
The distinction would be between “necessary” vs. “sufficient”.
Henderson is arguing against having a central bank at all. (“Wouldn’t it be nice if economists … challenged the whole idea of central planning?“) As part of the argument, Henderson disapproves of inflation: “Before the Federal Reserve existed, there was no problem of long-run inflation.” But this is an error, to conflate central banking with inflation. You can have central banking with, or without, inflation; and you can have inflation with, or without, central banking.
If you don’t like any inflation, then argue for that directly. (To be fair, Henderson does offer some arguments in the middle, e.g. “the almost total absence of long-term corporate bonds“.) At the moment, most monetary economists disagree; “long-run inflation” is not viewed as a “problem”, and nobody is trying to “solve” it. Central banking doesn’t cause inflation; central banking allows people who disagree to implement their preferred policy. You don’t need to eliminate central banking in order to eliminate inflation; you only need to convince the macroeconomic field that it would be a good idea. (It would already be trivially easy for the Fed to target 0% annual inflation instead of 2%.)
Jon Murphy
Apr 4 2022 at 12:17pm
Ok. But that’s still a central planning argument. You’re just arguing for changing the plan.
Don Geddis
Apr 4 2022 at 8:49pm
Yes! Exactly. There is no problem with central banking. Instead, the interesting question is: what is optimal monetary policy? What path should the money supply follow, in order to maximize economic flourishing? Depending on the answer to that question, a central bank might (or might not) be a useful tool to help the money supply along its optimal path. But a central bank is not by itself any kind of “problem”.
Jon Murphy
Apr 5 2022 at 8:59am
Yeah I’m sorry I am still not following. Since central banks are central planners, if they cannot figure out the optimal monetary level (assuming such a thing is even possible), then the problem is with central banks.
Don Geddis
Apr 5 2022 at 11:06am
That indeed would be the entire key … but it’s the first time you’ve mentioned it! I think we can all agree that, in the last century, the Fed often has not in fact figured out the optimal monetary level. But just saying “end the Fed”, and adopting something random instead (a gold standard?) is simply yet another monetary path, and also unlikely to exhibit the “optimal monetary level”.
Don’t you think it’s important to agree on what the “optimal monetary level” is first, before we criticize the various possible implementations? Maybe the Fed isn’t following the optimal path, not because central banking as an institution is somehow fundamentally broken, but instead simply because they don’t know (even in theory) what that optimal path is. How can you evaluate any monetary regime (whether central banking or not), if you don’t have an optimal model to compare to?
What is the ideal that the Fed is falling short of? What would perfect monetary policy look like? (Henderson doesn’t say!)
bb
Apr 4 2022 at 11:28am
David,
I don’t think this is a good use of the term central planning. If we label every service provided by the federal government to be central planning, the term loses meaning.
Also, you don’t seem to propose an alternative, which makes the criticism seem unserious to me.
Jon Murphy
Apr 4 2022 at 12:18pm
Note that’s not what is going on here. The Fed planning the money supply is not a service.
Spencer Bradley Hall
Apr 4 2022 at 2:16pm
Monetary policy objectives should not be in terms of any particular rate or range of growth of any monetary aggregate. Rather, policy should be formulated in terms of desired RoC’s in monetary flows, the volume and velocity of money, relative to RoC’s in R-gDp.
As American Yale Professor Irving Fisher said:
“In my opinion, the branch of economics which treats of these five regulators of purchasing power ought to be recognized and ultimately will be recognized as an EXACT SCIENCE, capable of precise formulation, demonstration, and statistical verification.”
We knew the precise “Minskey Moment” of the GFC:
AS I POSTED: Dec 13 2007 06:55 PM |
The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
10/1/2007,,,,,,,-0.47 * temporary bottom
11/1/2007,,,,,,, 0.14
12/1/2007,,,,,,, 0.44
01/1/2008,,,,,,, 0.59
02/1/2008,,,,,,, 0.45
03/1/2008,,,,,,, 0.06
04/1/2008,,,,,,, 0.04
05/1/2008,,,,,,, 0.09
06/1/2008,,,,,,, 0.20
07/1/2008,,,,,,, 0.32 peak
08/1/2008,,,,,,, 0.15
09/1/2008,,,,,,, 0.00
10/1/2008,,,,,, -0.20 * possible recession
11/1/2008,,,,,, -0.10 * possible recession
12/1/2008,,,,,,, 0.10 * possible recession
RoC trajectory as predicted.
Spencer Bradley Hall
Apr 4 2022 at 2:22pm
As I said:
Reply #4 posted Nov 26, 2019 at 6:45pm
Quote Edit
Post by flow5 on Nov 26, 2019 at 6:45pm
The 1st qtr. R-gDp in 2020 will be negative.
Spencer Bradley Hall
Apr 4 2022 at 2:28pm
The problem now is so acute that the economic engine must be run from a command economy. We got 12 Federal Reserve Districts. The Governor’s must be held accountable for something. If they miss their targets, they should be replaced.
Spencer Bradley Hall
Apr 4 2022 at 2:59pm
If the commercial bankers are given the sovereign right to create legal tender, then the DFIs must be severely circumscribed in the management of both their assets and their liabilities – or made quasi-gov’t institutions. It is past time that the banks should be nationalized.
Peter Lewin
Apr 6 2022 at 11:05am
”
Don Geddis Apr 4 2022 at 8:49pm
Yes! Exactly. There is no problem with central banking. Instead, the interesting question is: what is optimal monetary policy? What path should the money supply follow, in order to maximize economic flourishing? Depending on the answer to that question, a central bank might (or might not) be a useful tool to help the money supply along its optimal path. But a central bank is not by itself any kind of “problem”.
This kind of reasoning ignores the necessarily big discussion of the public choice aspects of central (interesting word) banking – the formidable knowledge and incentive problems that central bankers face. First we have to know what the optimal policy is then we have to figure out how to ensure that the CB is able and willing to implement it. It is beyond naïve, for example, to imagine that the Fed bankers are immune to the pressures of short-term opportunism (driven by elections and other pressures).
What’s the alternative? Look for less demanding more automatic (market driven) setups – rules v. discretion. Just saying.
Don Geddis
Apr 7 2022 at 7:23pm
I don’t actually think so. Central bankers have theory problems (they don’t know what the right thing is) … but not knowledge (at least, not “data”) or incentive problems.
I agree. It starts with the fact that money is almost always “neutral” (so inflation and the price level doesn’t really matter at all). And when not neutral, in special cases and only in the short run, the cause is generally “sticky prices” — especially wages. So avoiding unnecessary demand-side recessions is mainly about avoiding changes in nominal (not real) wage payments.
NGDPLT is an example of a monetary policy framework that would address the root cause of how money can affect macroeconomic stability.
I agree with you completely. Market Monetarism suggests targeting market forecasts of future NGDP expectations. No discretion at all; a simple computer could run monetary policy.
Michael Rulle
Apr 7 2022 at 10:08am
We live in a democracy—-the Fed was created in 1913 during a time of great change. JP Morgan, after the 1907 “panic”, strongly believed we could set up a permanent central function that did what he did to stop the 1907 panic. We also created a federal tax (16th amendment) in 1913–and voting rights for women were a few years away. I doubt we had any idea what a “Federal Reserve” could do –good or bad.
Now everyone has an opinion about the Fed—with no more knowledge than 1913. So eliminating it or decreasing its authority or monopoly would be a huge political nightmare. Who knows what would happen.
Anyway, few care if “central planning” is the optimal term—-but our readers would love to understand how monetary policy would work without a central bank. This subject is obviously complex—maybe too complex to risk moving away from the “continuity” path. There is something very safe (but still prone to error) to be said about the idea of Continuity (as Julian Simon wrote).
At the height of our inflation (1979) Hayek did propose that private banks could issue their own currency—-in competition with the Fed—but he had many ideas over his career.
Digital currency —–even with its larger stated objectives (like Etherium)—seems like something similar–certainly, Bitcoin does. But Blockchain tech makes it formulaic in a way that masks its utility —–but it seems like the closest idea to late stage Hayek.
Digital Currency, I assume, will find its optimal purpose—so we might get a look at competing currencies–although they are teeny in size today.
One thing seems very difficult to deny. Under the assumption that it is even plausible that the Fed should be able to get it right—which Monetarists believe to their core—-they “never” do.
By “never”, I mean we have no idea that when they do not screw up, it’s because it is hard to screw up—and when they do screw up it always seems to catch them by surprise–meaning it looks easy to screw up.
Lets not forget the randomizing machine called our Federal Budget——-I imagine the Fed as a baseball batter and the Federal Government a 105 mph pitcher using spider tack to enhance his cutter and back door slider.
How can the Fed get it “right?
Don Geddis
Apr 7 2022 at 7:27pm
It’s not at all that hard. There is no need to understand the complexities of the fiscal budget, or to try to predict it. A much better analogy for the Fed is a simple house thermostat: measure the current temperature, if it is below target turn on the furnace; if it is above target turn on the air conditioner. A simple feedback control system, to keep a chosen variable on target. The very complex outside weather of course affects the house temperature, but there is no need for the simple thermostat to model the earth’s weather. All it needs to do is to react to what it is seeing, in real time.
The Fed is the same, with monetary policy.
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