The Easiest Way to Cripple Our Economy: Let Politicians Run the Federal Reserve

By: Inoljt,

Several weeks ago, the House Financial Services Committee approved an amendment that would quite negatively impact our economy's future well-being. If passed, this change could hamper GDP growth for decades to come.

Offered by Congressman Ron Paul, the amendment vastly expands the Congressional Accounting Office's auditing powers over the Federal Reserve. Consequently, the Federal Reserve's cherished independence would be drastically curbed. Every unpopular action the Federal Reserve made could potentially be scrutinized by vote-seeking politicians. This would effectively intertwine politics into the serious business of running the economy - and if the Soviet Union taught us anything, that is a terrible, terrible idea.

Imagine, for example, if this policy had been in place three decades ago - during the 70s and 80s. The great economic challenge of those decades was stagflation, a ruinous combination of high inflation, high unemployment, and stagnant economic growth initiated by oil shocks. Presidents from Nixon to Carter attempted to combat the demon, instituting policies that ranged from price controls to handing out WIN (Whip Inflation Now) buttons.

The problem with stagflation, however, was that defeating it required extremely unpopular action - action no poll-reading politician was willing to take.

More below.

Ending stagflation meant lowering inflation, and combating inflation reduces short-term economic growth, often causing recession (if you find out a way to reduce inflation without doing this, you will revolutionize economics). No sane politician was willing to do this - and so the curse of stagflation remained year after year, crippling the nation's economy.

In the end, it was Paul Volcker and the Federal Reserve that defeated inflation. To defeat inflation, Mr. Volcker did something no politician would ever do - he started a recession. The Federal Reserve raised interest rates to a high of 21.5%, dramatically lowering the money supply to end inflation. Recession ensued, widespread protests occurred, and Republicans were roundly defeated in the 1982 congressional elections - but Mr. Volcker kept at it.

Eventually the public became convinced that, no matter what the political pressures on it, the Federal Reserve would not give in. Shopkeepers stopped raising their prices in anticipation of inflation. Companies stopped raising wages to match those price increases.

Inflation ended.

Unlike Congress and the President, the Federal Reserve had the will to do the unpopular but right thing. This ability was rooted in the Fed's independence from the whims of politicians facing re-election.

Imagine, now, if in 1982 the Federal Reserve had lacked such independence. Mr. Volcker raises interest rates; recession ensues. Then Congress, full of politicians facing uncertain re-elections, intervenes. Opportunistic congressmen hold hearing after hearing, demanding the Fed lower interest rates. The House begins investigative audits into the Fed, seeking to pressure the institution. Finally, Mr. Volcker buckles; he reluctantly lowers interest rates, sacrificing long-term economic stability for short-term growth. Inflation continues; the demon of stagflation remains - perhaps even to this day. Imagine the 2009 financial crisis occurring in a scenario of 10% inflation and 8% unemployment. That would be disaster indeed.

The 2009 financial crisis will not be the last. Economic bubbles will exist as long as humans do; humans always believe that "this time is different." If and when the next bubble pops - the next economic crisis hits - the United States will need an independent Federal Reserve. It will need an institution to do what is politically unpopular but necessary, as was the case last fall. The House's amendment threatens to destroy this safety net and deprive America's economy of an invaluable institution. The aggrieved sentiment behind it is understandable, but the Federal Reserve is not Wall Street, and Ben Bernanke was a Princeton professor of economics, not the CEO of Goldman Sachs.

Tags: Economy, Federal Reserve, independence, inflation, politicians, Politics, stagflation (all tags)



An easy rejoinder to a facile argument

1) You understate the amount of regulatrory capture by both the politicians and Wall Street by focusing on the tenure of Volcker; as it stands the Fed is a creature of a Wall Street run amok.

2) With the "indispensible" Fed on the beat, whence came 70s, 80s inflation in the first palce?

This is like calling Bernanke the "savior" of the economy when he was saying there was no housing bubble all along (let's not even bring up the crimes of Greenspan).

3) Most Democrats, leftists, liberals, Progressives, socialists etc. have no ideological or theoretical problem with government intervention in the economy (ironically, that sounds a lot like your hated Ron Paul) we just want it to be transparent and under democratic control.

4) Nothing could be a more Soviet institution than the Federal Reserve, but you seek to invoke Soviet Central Planning as something to be avoided. Which is it?

5) The issue at hand is transparency; don't misdirect by starting a new argument about the merits of an "independent" Fed.

6) Democratic government is more important thatn economic optimization, if the economy were to be less efficient with a government of, by, and for the people, I'm willing to take the "hit".

7) Come back when you've thought it through.

by Paul Goodman 2009-12-07 06:29AM | 0 recs
The Fed is not independent

It's dependent, a subsidiary, of the big banks.

by fairleft2 2009-12-07 06:55AM | 0 recs


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