In January 2008, Federal Reserve Chairman Ben Bernanke made this memorable announcement: “The Federal Reserve is not currently forecasting a recession.”
This was a poor forecast indeed, since as we now know, a very deep recession had already started by the time of the Fed’s prediction that there wouldn’t be one. This is only one of many such errors. If you have the unrealistic belief the Fed should somehow manage the economy, the financial system, inflation, employment, interest rates, financial stability and risk, you run into a granite wall of a knowledge problem. The Fed does not know and cannot know enough to do all this.
The simple fact is that the economic and financial future is not only unknown, but unknowable, for the Fed as for everybody else. It isn’t that the Fed is any worse than anybody else at knowing the future, including what the results of its own actions will be — but the Fed isn’t any better than anybody else either.
Yet, the Fed keeps insisting and has enshrined as part of its own confession of faith that it ought to be “independent”—to be an immensely powerful fiefdom answerable only to its own theories. Should the Fed be independent of Congress? Given the inherent human will to power, naturally it would like to be.
This desire to act as independent, economic philosopher-kings could be justified by a claim to superior knowledge. But such superior knowledge the Fed demonstrably does not have. Still, we cannot avoid observing that there is a strange faith in the Fed which is quite common. For example, it is endlessly repeated in the media that an inflation rate of 2 percent a year must be good because that is the Fed’s target, apparently without wondering whether this target is a good idea or not.
Of course, some people have more skeptically considered the 2 percent question. Olivier Blanchard, formerly the chief economist of the International Monetary Fund, has stated, “There is no sound economic research that shows 2 percent to be the economically optimal inflation rate.” He was arguing for higher inflation.
On the other hand, Alan Greenspan, when asked what the right inflation target was, said “zero” and added this wonderful Greenspanian hedge, “if measured correctly.”
A remarkable thing about the Fed’s current idea of an inflation target is that it is a target in perpetuity—2 percent a year forever. To commit for 2 percent a year forever means that in an expected lifetime of 82 years, average prices will quintuple. With a straight face, the Fed informs us that this is “price stability.”
Should Congress have anything to say about whether it wants inflation of 2 percent a year forever?
The Fed often states that “price stability” is part of its statutory “dual mandate.” The reference is to the Federal Reserve Reform Act of 1977.
But this law does not say, “price stability.” It says “stable prices.” It does in particular not say “a stable rate of inflation.” It says “stable prices.” Does the term “stable prices” mean perpetual inflation? What did Congress mean by “stable prices” when it put that term into law?
We learn from the minutes of the Federal Open Market Committee that in 1996, when the Fed was discussing whether it should have an inflation target, one member of the committee dared to ask what Congress meant by the statutory language.
This question was quickly passed over and not pursued. But it was a good question, wasn’t it?
In fact, we have a good indication of what Congress meant by “stable prices.” The very next year, in the Humphrey-Hawkins Act of 1978, Congress provided “the goal of achieving by 1988 a rate of inflation of zero.”
Obviously, this was not achieved, and somehow we never hear the Fed discussing this goal as expressed in statute. Bernanke advised his successor as head of the Fed, Janet Yellen, to remember that “Congress is our boss.”
But does the Fed believe that Congress should be its boss? That these mere politicians, elected by the People, should be the boss of the high powered economic and financial experts of the Fed?
Former Senator Proxmire once put the case for the Congress pretty bluntly in a hearing:
“You recognize, I take it, that the Federal Reserve Board is a creature of Congress? ... [that] the Congress can create it, abolish it, and so forth?”
That is true, but short of abolishing it, what steps can be taken for greater accountability and more effective Congressional governance of the Fed?
It seems to me the best model might be to think of the Congress as the board of directors, and the Federal Reserve officers as the management, of the government’s operations in money. With this model in mind, the relationship of the Fed and Congress should evolve into a grown-up, real discussion of issues, alternatives, strategies and risks. That would be quite a contrast to the media event that Fed testimony now represents.
Such discussions might even include the Fed’s asking the Congress what it means by “stable prices” as a goal. Of course, the Fed could lay out all its arguments for 2 percent inflation and its thoughts on alternatives for congressional consideration. Can you imagine that?
Perhaps you can’t, but as the 104-year history of the Federal Reserve demonstrates, many things which were previously unimaginable nevertheless came to pass.
