Philadelphia Federal Reserve president Charles Plosser thinks the Fed has gone too far.
Plosser, in a Nov. 23 speech before the libertarian think tank the Cato Institute, proposed four limits on the central bank that he said would reduce the central bank’s discretion and, by doing so, improve its outcomes and accountability and maintain its independence.
He would limit:
The Fed’s monetary role to a narrow mandate with price stability its primary objective.
The type of assets the Fed can hold on its balance sheet to Treasury securities.
The Fed’s discretion in monetary policy by requiring a rule-like approach. This contrasts with the broad spectrum of policies implemented in 2008.
The boundaries of its lender-of-last-resort credit extension.
Plosser is concerned that the Fed’s massive purchases of mortgages of uneven credit worthiness has undermined the credibility of the U.S. dollar and has reduced the quality of the central bank’s balance sheet.
Plosser questioned the Fed’s use of quantitative easing, its unconventional monetary policy of buying securities to stimulate the economy when standard monetary policy has become ineffective. The Fed’s balance sheet has grown from less than $1 trillion to almost $4 trillion since 2008. Lastly, Plosser questioned the bailouts of Bear Stearns and AIG.
In suggesting that Congress should limit the Fed to maintain faith in the dollar, Plosser is effectively endorsing some of the policy positions of libertarian Ron Paul.
But before Paul and Plosser, similar ideas were espoused in 1967 in the criticism of the Fed by Nobel Prize-winning economist Milton Friedman.
“We are in danger of assigning to monetary policy a larger role than it can perform, in danger of asking it to accomplish tasks that it cannot achieve, and as a result in danger of preventing it from making the contributions that it is capable of making,” Friedman wrote.
Friedman was correct.
Fed policies were so ineffective during the early 1970s that we suffered from a prolonged period of slow economic growth, high unemployment and high inflation (stagflation).
Under the leadership of Paul Volcker, who was Fed chairman from 1979 to 1987, the central bank focused solely on stamping out inflation. Volcker succeeded because he took draconian measures that led to short term rates rising above 20 percent.
Plosser says the Fed’s attempt to promote both low unemployment and low inflation has contributed to an expansionary view of the powers of monetary policy.
He argues that this is beyond Congress’ intention when it established the current set of monetary goals in 1978. At that time, Congress amended the Federal Reserve Act to stress the “long-term growth” of money and credit, commensurate with the economy’s “long-run potential.”
In other words, if the economy grows at 3 percent, then the money supply should only grow at 3 percent.
Plosser does not think Congress authorized the Fed to manage short-term fluctuations in employment — its focus now.
Plosser argues that today’s Fed policies could have very undesirable repercussions, including damage to the public’s confidence in the institution, its legitimacy and its independence.
Plosser concludes that the Fed should redefine its monetary policy to focus primarily on price stability because:
Monetary policy has very limited ability to influence employment.
Now that America has abandoned the gold standard, only the Fed, by employing conservative policies, can ensure the public’s faith in the dollar and price stability.
I hope that the Fed, under its presumed new chairwoman, Janet Yellen, reins in QE and returns to implementing only conventional monetary policies.
Without that, I worry that quantitative easing, combined with massive government deficits, will lead to damaging stagflation in the U.S.
Originally published in the Sarasota Herald-Tribune
