Academic journal article Journal of Private Enterprise

A Modest Proposal for Reining in the Unorthodox Fed

Academic journal article Journal of Private Enterprise

A Modest Proposal for Reining in the Unorthodox Fed

Article excerpt

I. Introduction

"Unorthodox" monetary policies were devised in reaction to the financial crisis by unaccountable and unsupervised Federal Reserve bureaucrats led by then Fed chair Ben Bernanke. These "unorthodox" or "unconventional" policies include the zero interest rate policy, policy duration commitment, quantitative easing, and credit easing.1 They have been used to drive the (riskless) interest rate to zero and to recklessly expand the monetary base and, to a lesser extent, the money supply. Under the guise of its function as a lender of last resort, the Fed under Bernanke also contrived a host of one-off programs that have usurped the credit allocation function of financial markets (White 2014). The central policies of the unorthodox Fed have continued unabated under the chairmanship of Janet Yellen. The grudging acquiescence of both the public and politicians in this unprecedented expansion of Fed powers is attributable to the intellectual dominance that the doctrine of Fed independence achieved during the Greenspan era.

The next section briefly recounts how the idea of an independent central bank came to command such widespread and unquestioned acceptance during the two decades leading up to the financial crisis. Section 3 describes the rapidly intensifying disillusionment with the Fed that emerged during the stagnant recovery from the Great Recession and that now threatens its independence. Section 4 describes and evaluates the feasibility of a proposal for stripping the Fed of its independence within the framework of the current fiatdollar system.

II. The Emergence of the Ideal of Fed Independence

During the 1980s and 1990s, the desirability of the "independence from politics" of central banks became almost an article of faith among mainstream macroeconomists and those operating in financial markets.2 This development was driven by two factors: academic research on central banking, and the personality cults that grew up around the two Fed chairmen during this period, Paul Volcker and Alan Greenspan.

Research on central banking became a veritable growth industry during the 1980s and 1990s.3 A great deal of this research early on was devoted to examining the effects of central bank independence on the inflation rate. The consensus view that emerged from this literature was that central bank independence was strongly correlated with lower inflation rates and no appreciable deterioration in real output performance (see, e.g., Alesina and Summers 1993).

Further research in the 1990s focused on the optimal design of a central bank. This research led to the discovery of a pronounced decline in the level and variability of the inflation rate accompanied by a reduction in the volatility of real output that began in the mid 1980s.4 Thus was born the myth of the "Great Moderation," which spanned the roughly two decades from 1985 to 2006. This new era of macroeconomic stability was attributed in large part to the "quiet revolution" in central banking, which involved fundamental changes in the structure and operating procedures of the Fed and other central banks (Blinder 2004). The paradigmatic shift in central banking organization was widely touted as the result of the newly emerging consensus among economists regarding the optimal organizational structure of a central bank. The revolution was instantiated in the three major central banks-the European Central Bank, the Bank of Japan, and the Fed-which were designed or redesigned "from scratch" during the 1990s based on the new research in monetary policy (Blinder 2004, p. 56; Cecchetti and Schoenholtz 2011, p. 384). A salient feature of these newly designed central banks was the enhancement of their formal independence from government and politics. This narrative became a new orthodoxy among economists and quickly became entrenched in textbooks on money and banking and on macroeconomics.

In a famous speech in 2004, Ben Bernanke (2004), then a Fed governor, proclaimed "that improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation. …

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