Issue #20, Spring 2011

Fed Up

The Federal Reserve is shrouded in obscurity. That’s partly its fault—but it’s partly progressives’ fault, too.

Bored by the proceedings at the Republican National Convention in St. Paul one day in 2008, I decided to try to gather some color down the road in Minneapolis, where Ron Paul and fellow dissident conservatives and libertarians were holding a counter-convention at the Target Center. At one point a speaker thundered that Barack Obama and John McCain “both have a lot to learn about Austrian business-cycle theory.” The crowd went delirious with cheers, and soon chants of “end the Fed” echoed throughout the arena.

It was funny at the time. A bunch of cranks talking about their crank monetary theories and espousing a crank prescription.

Today, Paul is the chairman of the House Subcommittee on Monetary Policy.

And though the House GOP presumably won’t be pressing the full Paul agenda of eliminating the Federal Reserve System and returning the United States to the gold standard, his ascension to the job isn’t a pure coincidence, either. House Republicans don’t assign chairmanships by strict seniority, and in the past, GOP leaders had kept Paul away from too prominent a role in monetary matters. Now he’s getting a seat at the table and Paulite views that see the Fed as pursuing dangerously inflationary policies are moving toward the mainstream.

As recently as 2009, the Federal Reserve’s emergency efforts to keep the economy afloat were sufficiently uncontroversial that Time named Chairman Ben Bernanke its Person of the Year. Earlier that summer, Barack Obama chose to reassure markets by leaking—well in advance of the need to make a decision—that Bernanke would be reappointed to lead the central bank. And yet, by the time the confirmation vote was actually held in late January 2010, Bernanke got in by a margin of just 70-30, the slimmest of any Fed chief ever. That nearly half of Senate Republicans voted no is especially striking when you consider that he was originally put in the job by George W. Bush, had previously chaired Bush’s Council of Economic Advisers, and before that had done an earlier stint in a lesser Fed role, again at the behest of Bush.

At the time it was possible to interpret this reversal on the part of so many GOP senators as just another sign of partisanship run amok: They were opposing him simply because Obama was the one doing the nominating. But as the economy slowed again in 2010, and the Fed initiated a new round of so-called “quantitative easing” (QE)—central bank purchases of long-term Treasury bonds to increase the money supply and stimulate the economy—it became clear that Republicans were genuinely moving toward a critique of the whole idea of stimulative monetary policy. This was striking because stimulative monetary policy had been since Milton Friedman’s day the main conservative alternative to Keynesian fiscal stimulus.

In mid-November, the conservative economics think tank e21 released “An Open Letter to Ben Bernanke” complaining that his policies risked currency debasement and inflation. True, e21 is not itself a particularly influential or well-known institution, but the letter was co-signed by influential journalist/tactician Bill Kristol; Kevin Hassett from the American Enterprise Institute; Douglas Holtz-Eakin, founding president of the new American Action Network, intended to be the right’s answer to the Center for American Progress; and other heavy hitters. Shortly thereafter, Indiana Congressman Mike Pence and Tennessee Senator Bob Corker, both Republicans, joined the party, criticizing quantitative easing and urging that the Fed’s mandate be shifted from its current dual focus on inflation and employment to a single focus on price stability.

On the merits, these conservative complaints are absurd. After then-Fed Chairman Paul Volcker and Ronald Reagan beat inflation in the early 1980s, annual increases in the Consumer Price Index (CPI) hovered around 4 percent per year for the rest of the decade. After the recession of the early 1990s, the Fed held inflation mostly below 3 percent for almost 20 years. Since the onset of the Great Recession in December 2007, the CPI’s rate of increase has been steadily lower than even that. At the same time, unemployment has been sky-high, real growth has been first negative and then disappointingly slow, and overall consumer demand has been well below the pre-crisis trend. The idea that a time of unusually high unemployment and unusually low inflation would be a good moment for monetary policy-makers to start caring less about growth and more about price stability, especially when we already have price stability, is bizarre.

In response, Paul Krugman has called on progressives to “denounce Republican attacks on the Federal Reserve and defend the Fed’s independence.” But we need something better than a simple circling of the wagons around the powers that be. After all, people are angry for the very good reason that economic performance is currently very bad. And unlike a lot of the targets of popular anger in the Obama era, from autoworkers to hedge fund managers, America’s central bankers are in fact the ones who are supposed to deliver decent macroeconomic outcomes.

Most important, for all the flaws in the right’s current critique of the Fed, they’re correct to point to the need for accountability. The idea of a central bank that’s “independent” of day-to-day politics is a good one, but too often that’s come to mean a central bank that’s immune from criticism or meaningful supervision. The Federal Reserve System’s current vague mandate needs to be replaced with a specific target, defined in law. The public and the politicians we elected need to be prepared to hold the system accountable for achieving the target, and Congress needs to accept responsibility for picking a target that leads to good outcomes. Most of all, progressives need to start caring about the Fed and engaging in the debate over what it does.

The Fed and Its Works

Everybody knows that the Federal Reserve chairman has an important job, but few people understand what the institution he supervises actually does. The overall system undertakes a variety of activities, of which by far the most important is to set monetary policy: adjusting the quantity of money available to the economy.

This is done by the Federal Reserve’s Open Market Committee (FOMC), which is composed of the seven members of the Federal Reserve Board of Governors (the chair, the vice-chair, and five other governors), plus the president of the New York Fed and, on a rotating basis, the presidents of four of the other 11 regional Fed banks.

Each of the regional Feds has its president selected by its own board of directors. These boards, in turn, are composed of three classes of directors. Class C directors are appointed by the Board of Governors in Washington. The Class A and Class B directors are appointed by the member banks, with Class A directors representing banking interests and Class B directors representing local economic interests. The governors who sit in Washington are appointed by the president and confirmed by the Senate.

The FOMC’s mandate, as defined by the Federal Reserve Act, is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” This is conventionally called a “dual mandate” in that it references both employment and inflation. (Foreign central banks often have a single mandate to focus on inflation. Some describe the mandate in qualitative terms—like the United States does—whereas others have specific numerical targets.) The Fed pursues its mandate through so-called “open-market operations”—the buying and selling of bonds. In normal times, the Fed sets a target for short-term interest rates, announcing an intention to make them either higher or lower. Then it follows up with sales or purchases of short-term bonds. Buying bonds drives rates down, and selling them pushes rates up. But just as crucial as the Fed’s actions—if not more so—is the body’s announcement of its actions. After a meeting, the FOMC releases a statement describing its intention to shift rates up or down by a certain amount. Since market participants know exactly what the Fed is trying to do, private traders start buying or selling on the assumption that the Fed will hit its target, meaning that the quantity of bonds actually bought or sold by the Fed is rather modest in practice because private investors do most of the lifting. Purchasing bonds puts more money into the economy, creating conditions of “easy money,” and is known as “easing.” Selling bonds makes money “tight” by pulling it out of the economic system.

When short-term rates are nearly zero, as has been the case recently, the Fed can’t generate looser money through this method. But it does at such a moment have the option of buying or selling longer-dated bonds and trying to influence the economy. When the Fed does this, it sets not a target interest rate but a target quantity of bonds to be purchased—hence the term “quantitative easing.” By misguided journalistic convention, a “normal” action to reduce rates from 3.75 percent to 3.50 percent is termed “cutting interest rates,” whereas recent QE measures were reported by some in the media in near-apocalyptic terms as the Fed printing billions of dollars and purchasing vast amounts of bonds. These descriptions are not inaccurate, exactly, but they lack context—printing money and buying and selling bonds are what the Fed does all the time.

The Unaccountable Fed

Politicians talk about jobs all the time. President Obama seems to talk about them in every other speech, while Republicans constantly talk of the “job-killing” effect of Democratic policies. The truth is that questions about creating jobs ought to be directed at the Federal Reserve, the federal agency that’s been charged with primary responsibility for stabilizing the economy. Recessions normally come about because the Fed raised interest rates to curb inflation, and they normally end when the Fed cuts interest rates to spur growth. At times, fiscal policy—such as the stimulus passed in 2009—enters the picture as an additional means to stoke demand.

But even then the monetary authorities are crucial. Most of the time one would worry that demand created by a higher federal deficit would be offset by the fact that more borrowing raises interest rates, stifling growth. This is the technical version of the man on the street’s objection to stimulus that “the money has to come from somewhere.” Appealing though this idea may be, it is in fact false. As Bernanke put it in a 2002 speech, “[T]he U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” By using this technology, the Fed can ensure that interest rates stay low even in the face of large deficits.

This free lunch is available amidst deep recessions because such events are defined by the widespread idling of resources. A recession means the country has able-bodied people who aren’t working, factories that aren’t running, and office space and storefronts that are vacant. Fiscal and monetary stimulus aims to mobilize that excess capacity. When there is no excess capacity, printing money to keep rates low will simply lead to inflation. The country’s ability to produce money may not be limited, but its ability to produce goods and services is, and inflation is what happens when the government attempts to stimulate demand above the country’s ability to produce. Increasing productive capacity is the key to long-term prosperity, but adequately matching demand to current capacity is the key to the short-term employment and economic growth picture.

Clearly, the Fed bears enormous responsibility for the health of the economy. But the way the current system works, the Fed’s members are hardly ever held accountable when the Fed fails to live up to that responsibility. The current Great Recession is, like all passing economic disasters, a major failure of macroeconomic stabilization. On the one hand, in its role as bank regulator, the Fed clearly failed to prevent widespread misbehavior. On the other hand, as a monetary policymaker, the Fed let inflation expectations fall well below customary levels even as output and employment were plummeting. Yet so far the key monetary policy-makers have been reappointed, and discussion of the issue has been dominated by cranks warning of nonexistent inflation and pushing for antiquated ideas like a gold standard. And the Fed did, in fact, engage in a flurry of unfamiliar activity to support the economy. So at the very time the collapse in output suggested the need for even more unorthodox monetary expansion, the aggressive expansion itself invited criticism that too much money was being created or that the Fed was simply continuing an unduly cozy relationship with the banking sector.

Much of the blame lies with the Fed’s current statutory mandate. Simply put, it is maddeningly vague. The interpretation of both “maximum employment” and “stable prices,” as well as the correct balance between the two, is up for grabs. Some FOMC members (or some members of Congress) may decide that 2 percent inflation is too high and the concept of “stable prices” should be re-interpreted to mean something closer to 1 percent or 0 percent inflation. Alternatively, many or most FOMC members may believe that the kind of more drastic QE measures that would be necessary to boost growth and inflation to target levels would be too politically damaging to undertake. Most plausible of all is that we’re currently experiencing some combination of the two. Some members probably regard sky-high unemployment as a price worth paying for the goal of a reduced rate of inflation, while others would prefer to do more but worry about the politics. The result is to leave the FOMC semi-paralyzed and unable to offer a fully coherent account of its own conduct. A candid description of internal disagreements and the resulting policy compromise would ameliorate the communication problem, but at the cost of undermining the aura of unanimity that the Fed relies upon to preserve its credibility and independence.

Nobody can say the FOMC is doing a bad job because nobody can say definitely what its job is. Not only the committee itself, but each individual member thereof, is free to define the FOMC’s mission freelance. Policy-making is essentially an accountability-free zone.

But while FOMC members are overempowered to set their own goals, they’re underempowered to push back against outside critics who don’t like the smell of certain unorthodox measures or who simply have partisan political motivations. Without an unambiguous mandate to follow, critics and interested parties can easily politicize unfamiliar moves.

Conversely, failing to define a clear mission for the Fed is a convenient way for Congress to duck responsibility for economic decisions. A clearer mandate for the Fed would make it easier for Congress to hold the central bank accountable for poor performance, but it would also force politicians to focus more clearly on who is responsible for what. Past economic calamities have, appropriately, prompted rethinking of monetary policy—the key lever for providing macroeconomic stability. Amidst the Great Depression, FDR’s Administration took the dollar off the gold standard, creating, in effect, an enormous expansion in the money supply and setting the stage for recovery. And after the tremendous inflation of the 1970s, the Fed was refocused on fighting price increases and was distanced from the president’s short-term political interests. The economic calamity of our generation ought to provoke a similar rethinking—one aimed at empowering the central bank to respond forcefully to a big crash while also demanding that it deliver results. There’s no reason we should listen to the cranks, but we should at least hear them and recognize that they’re gaining credibility for the very good reason that the powers that be have failed and nobody else is talking.

One step in this direction would be to start taking Federal Reserve governance more seriously. Currently the chairman of the system tends to be a quasi-celebrity post, but the other members of the Board of Governors languish in obscurity. It’s like forgetting that the associate justices of the Supreme Court have important jobs. Even worse, the regional bank presidents are, in part, selected by private banks in a way that wreaks havoc on any notion that policy should be accountable to the public interest.

Time for Accountability

The first step toward reform should be fixing the appointment process so that accountability is at least possible. Contemporary American politics is shot through with accusations that policy is unduly dominated by the financial-services industry, and nowhere is this truer than in the bizarre status of the regional Federal Reserve Bank presidents.

The initial setup of the Federal Reserve System was intended as a decentralized compromise between big business’s desire for monetary authority and American populism’s traditional suspicion of central banks. But by dividing authority among 12 regional banks and then placing the regional banks substantially under the control of local member banks, we’ve gotten the worst of both worlds—diffuse authority that’s still substantially under the thumb of the structural interests of the banking industry. During the current crisis, for example, the most skeptical voices from inside the Fed about why it shouldn’t be doing more to fight unemployment have consistently come from the regional bank presidents in Dallas, Minneapolis, and especially Kansas City. It was precisely this fear of creditor interests crushing the economy with anti-inflation zeal that populist opponents of central banking worried about a century ago.

Monetary policy is a public function, and it should be conducted by public officials who are accountable to other public officials. There are two possible paths to reform on this point. One would be to take away the regional bank presidents’ rotating seats on the Open Market Committee, cutting them out of any role in making monetary policy. This would limit them to conducting the business of regional banking services and economic research, leaving monetary policy in the hands of the Board of Governors.

In addition to reducing the corrupting influence of private banks, this would also take account of the reality that monetary policy is not the primary function of the regional bank presidents. Consequently, regional bank presidents are typically not monetary economists, and in some cases aren’t economists at all.

Another approach, closer to the decentralized spirit of the original setup, would be to maintain—or even strengthen—the regional presidents’ current role but eliminate member banks from their role in selecting the board members. Class A and Class B board members could be selected by the governors of the states within a bank’s jurisdiction. Or instead of governors, responsibility could be vested with senators or state legislatures. The point, in any case, should be to ensure that public power is accountable to public officials who, in turn, are accountable to the voters rather than to private firms who are accountable to shareholders.

But beyond changing the process by which its members are selected, Congress ought to give the Fed a new and clearer mission. Instead of treating central bankers like mystical figures (“maestro”), they should be seen as what they are—technicians who hit targets by manipulating interest rates and public expectations. That means giving the central bank a single, unequivocal target. If the FOMC hits the target, then Congress should give its members a nice round of applause. If the committee falls wide of the mark, then it’s time to break out the denunciations and make sure not to reappoint anyone until they do better. If the FOMC feels that extreme measures are necessary to hit the target, then they can point panicking pundits and whining politicians to the congressionally approved target and get on with the job. And if targets are being hit but members of Congress don’t like the results, then lawmakers will have to take responsibility and either tweak the target or change something else in the policy environment to improve matters.

As for the crucial matter of what the target should be, there are a number of options. One would be to copy the Bank of England, which has an explicit mandate to achieve inflation of roughly 2 percent. That would approximate the Federal Reserve’s practice in the 1990s and 2000s, when nobody seemed bothered by the inflation rate. Indeed, such a target would have legitimated all the expansionary activities the Bernanke-era Fed has undertaken thus far, and would have even mandated additional monetary stimulus. Concurrently, people worried by the recent unorthodox measures would be reassured that these are undertaken with reference to the same old goals under new conditions.

Other ideas more exotic than current practice exist in the economics literature, including targeting the price level rather than the inflation rate or attempting to directly target overall aggregate demand. The details are interesting to debate, but for our purposes the main point is that whatever target is chosen, the job of monetary policy should be to hit it—to keep market expectations anchored near the target. That, of course, leaves open the possibility that an economy steadily hitting its targets will suffer from serious problems. Maybe people will find the inflation rate troublingly high. Or perhaps real output will be troublingly low. This, then, becomes a problem for America’s elected officials, who will need to take responsibility for the consequences of the mandate they handed to the central bank.

The appropriate response to a dragging economy might involve anything in the familiar litany of policy changes—lower taxes, more infrastructure spending, better education, changes to trade or energy policy, etc.—but policy-makers would also be asked to confront the possibility that the problem lies with monetary policy. Encouraging Congress to do so cuts against the grain of the fetishizing of central bank independence that came into vogue during the so-called “great moderation” of the pre-crisis years. On the assumption that a great moderation had been achieved, the fetish was understandable. But if a catastrophic failure of macroeconomic stability doesn’t cause a rethink of our approach to stabilization, then what would?

The day-to-day operational independence of the Fed should be maintained, but respectable opinion has gone too far in construing independence to entail a lack of accountability. No public institution can or should be truly independent of the political process. The Supreme Court is an independent branch of government, and rightly so. But its decisions are subject to hot political debate, and the nomination of judges to sit on the high court is considered an important presidential power. This, too, is as it should be. The assumption that monetary policy is too important to hold central bankers accountable through the political process should have come to an end along with the illusory great moderation.

The Challenge to Progressives

Large-scale change is unlikely to emerge in the near term. But for starters, progressives need to get in the game. The failure to control inflation in the 1970s served to substantially discredit the postwar Keynesian mixed economic synthesis. Progressives were initially optimistic that the great crash of 2008 would discredit the Reaganite paradigm, but as poor economic conditions linger into a Democratic presidency, there’s a real and growing risk that the reverse will happen. Central banks and monetary policy are the primary determinant of short-term economic conditions—of the unemployment rate, and thus of workers’ ability to bargain for wages. This is, clearly, a hugely important subject in its own right. But it’s also a critical determinant of overall political conditions.

Think back to the late 1990s and the booming economy under Bill Clinton. It’s little-remembered today, but as of the first half of that decade, the conventional wisdom in many circles held that to allow the unemployment rate to fall below 7 percent would be to risk dangerous inflation.

Alan Greenspan, no particular friend of progressive politics, disagreed. The result was an extension of the boom and the only period of sustained wage growth for working people in 30 years. As a bonus, the Democratic Party’s credibility on economic management was restored and Clinton’s popularity soared high enough to let him survive a major sex scandal.

But when Barack Obama was elected in 2008, he rather hastily chose to reappoint Bernanke, creating a situation in which no Democrat has held the most important domestic policy job in the land since 1987. He inherited two vacancies on the Board of Governors that he left open for over a year, only putting names forward after a third vacancy emerged in 2010. Once the nominees were picked, neither the Administration nor the Senate leadership made confirming them a matter of urgency, and they languished for months before the Senate Banking Committee. After months of delay, two of Obama’s picks were confirmed unanimously on September 30, but as of this writing, his third choice, MIT economist Peter Diamond, is still in limbo thanks to objections from Republican Senator Richard Shelby of Alabama, who deems him unqualified. Somewhat absurdly, while waiting to pass Shelby’s muster, Diamond won a Nobel Prize in Economics.

And yet throughout a period in which both Obama and Senate Republican obstructionism have taken hefty criticism from the left, little has been said about this situation. Of course, no one can know for sure what the Fed would have done had Obama picked someone other than Bernanke to chair it or filled the vacancies more rapidly. But it’s certainly plausible that different personnel would have led to swifter and more forceful moves toward monetary stimulus, a more rapid end to the recession, and a lower unemployment rate. The consequences of such a scenario for the American worker, for the president’s approval ratings, for the 2010 midterms, and for the entire progressive agenda would have been dramatic. These were, in other words, likely much more serious miscalculations than are generally realized.

Few people realize it in part because progressives in general aren’t accustomed to thinking about monetary issues. That, in turn, is largely because in the progressive movement monetary policy doesn’t seem to be anyone’s job. Climate change, health care, labor unions, women’s rights, gay and lesbian equality, and poverty, among other causes, all have their advocates. And faced with an economic downturn, fiscal stimulus is an appealing prospect to liberals. After all, it offers a political free lunch—an opportunity to spend money on key priorities without doing the tough work of coming up with offsetting tax increases. And it’s easy enough to dial around to a dozen interest groups and come up with a laundry list of stimulative fiscal measures. But the vast majority of recessions are fought primarily with monetary tools rather than fiscal ones. And even in especially steep downturns, fiscal policy can work as a stabilization tool only to the extent that monetary policy accommodates it. What’s more, most liberals claim to care about things like wage stagnation but seem to have remarkably little interest in the institution charged with determining when “too much” increase in compensation is risking inflation.

In our stovepiped movement, nobody is watching the basics of economic stability. This is a major lacuna in the progressive institution-building of the past ten years. Unless people are so naïve as to think we’re currently living through the last major recession in world history, it’s a gap that needs to be filled. Putting a non-conservative in the Fed chairman’s seat would be a nice start. And more programmatic emphasis is needed in our think tanks and journals to bridge the gap between academic research on monetary policy and the political world. The institution that failed us so badly in the current crisis is bound to fail again, and it’s crucially important that next time, there’s someone out there ready to talk about it other than Ron Paul.


More from Democracy: A Journal of Ideas

Federal Case by Michael Lind

Read More »
Issue #20, Spring 2011
Post a Comment


Maybe you should explain in your article what Austrian Business Cycle Theory is...

Or do you not even know?

Mar 17, 2011, 11:22 AM
Some Guy:


Tom Woods just took you to school:

You really should try learning what the Austrian School actually says before you embarrass yourself like this again.

Mar 18, 2011, 12:29 AM
Some Guy:

Nobody can say the FOMC is doing a bad job because nobody can say definitely what its job is

Bullshit. The job of the Fed is, and has always been, is inflating the currency to maximize the profit of the banks that own it, and enable profligate spending by the government. Any other ostensible purpose of the Fed is nothing but propaganda.

Mar 18, 2011, 12:37 AM
Hugh D:

There is rarely anything that is quite as embarrassing as witnessing someone pretending to speak with authority on a subject that he so clearly knows nothing about.

Mr Yglesias, as an economist, I would strongly encourage you to stay well away from this subject material in future.

Mar 18, 2011, 5:15 AM

it's a little sad to see the state of progressives fall so low. There was a time that they were willing to stake unpopular positions... Yglesias is now no more than a shill for the regime, fitting comfortably on the political spectrum in that wide space between Joe Biden and Mitch McConnell.

Oh for the days of true radicalism, willing to question the War on Drugs, Terror and now, the economy.

Mar 18, 2011, 10:21 AM

I guess this is what passes for a "progressive" in the U.S.

A Progressive seems to be just another way to describe a shill for the status quo.

Mar 18, 2011, 10:34 AM
Keith Snyder:

This piece reminds me of a similar pile of poorly collected prose that ended up in Forbes a couple weeks back where the guy mentioned "Austrian Economics" then wondered what the economy of Austria had to do with anything. And no, he wasn't kidding. Just amazingly ignorant. But then most regime suck-ups like this guy and the Forbes guy (who shall remain nameless here although anyone with a brain could pick him out of the "contributors" line up just by reading a few lines of his endlessly partisan hack bulls**t) are just that ignorant. And in some cases just aren't that bright in the first place.

Mar 18, 2011, 12:14 PM

I sense a lot of attitude in these comments, but no actual substance.

Shouting loudly that your theories are correct and Matt is ignorant does not constitute an argument.

Funny how Matt frequently attracts this variety of agitated yet incoherent opposition.

I read Tom Wood's "takedown". It's basically a fact-free rant, larded with this kind of gratuitous imputation of sinister motives: "Yglesias is beside himself that so many people had adopted a view that neither he nor his friends had approved for them in advance."

Right, because We All Know that Liberals Are Elitists. This is mere recitation of an ad-hominem mantra.

Mar 18, 2011, 2:48 PM

Adding: It's funny that Matt's article, which isn't actually about the Austrian business cycle, inspired so much passionate defensiveness about that subject. Yglesias didn't explain it here because it's not his focus here. If you feel the need to pen angry 2000-word screeds about Austrian theory in response to an offhand remark, you might want to consider getting out a bit more often.

Mar 18, 2011, 2:53 PM

I'd say Yglesias gave the Austrian School exactly the level of attention as it deserves -- a quick punch line before moving on to an actual discussion of monetary policy.

He didn't discuss the tenets of Scientology either.

Mar 18, 2011, 3:00 PM

"Yglesias didn't explain it here because it's not his focus here."

Oh....that's why he didn't explain it.

Mar 18, 2011, 3:17 PM
Central banks and monetary policy are the primary determinant of short-term economic conditions—of the unemployment rate, and thus of workers’ ability to bargain for wages.

If this is true, then you must admit that all of our past depressions, recessions, or whatever you want to call them, were indeed the central bank's fault.

Mar 18, 2011, 3:33 PM

"Some Guy", "Derrick"

Before I begin I would like to point out that if either of you actually knew anything about ABC theory, you would know that it directly implies market economies are inherently sub-optimal and flawed. If investors correctly anticipate that a decline in interest rates will be temporary, they won’t evaluate long-term investments on the basis of current rates. Austrian story requires either a failure of rational expectations, or a capital market failure that means that individuals rationally choose to make ‘bad’ investments on the assumption that someone else will bear the cost. A rather Keynesian outlook, and the basis for the two intellectuals' competitive friendship over the years.

With that said, I believe you are the ones who are severely undereducated, especially with that Lew Rockwell link. If you believe the "Austrian school" of economics to be anything more than an ideologically-based abstraction, you need to step back into Macroeconomics 102.

First off, the entire school had it's ideology written in stone before the advent of modern Federal Reserve banking. It is true; when almost all of the influential Austrian ideas were formed, "The Fed" as we know it today simply did not exist (1913 was well after the von Mises analysis). To get around this, they purposefully use over-generalized definitions of what "Federal Reserve" means which are completely unhelpful and allow the term to be misapplied by crackpots like you to historical institutions pre-1913.

Secondly, the school divorces itself from mathematics, history, and data analysis in general, which effectively accomplishes what the Christian church does, by placing themselves in an entirely different context than their critics. They knowingly do this to make it impossible for one to argue against them on their own terms. In fact, the mathematics and history prove ABC wrong, because according to the ABC model our "malinvestments" and the subsequent "resource reallocation" should have meant an unemployment increase of no more than 0.6%/year over the course of the recession. In fact the numbers are 20 times this. So ABC theory starts telling a story, but it only tells 5% of a story. Now that s a lame model.

To add to the empiric refutation of ABC theory, the model also implies that unless Say's Law is tossed, consumption should negatively correlate with investment over the business cycle. The opposite is true. Malinvestment-driven booms actually correlate with high consumption, as one would expect.

Austrians have not taken the care to seriously address such gravely damning empirical critiques which have emerged a few decades after their (admittedly) then-groundbreaking ideas. This leaves them a skeleton, nothing more than quasi-religious ideologues.

Oh, I don't want to forget to mention that the founders of the school were not actually economists. The field was known as "political economy" at the time, and the Austrians were political philosophers, like Hobbes or Locke, not proto-economists like Mill, Marshall, or Pareto.

Anyway, if you got this far at least you learned something. A little caveat though since i found this on SU, its unlikely that I will muster the time or energy to find this particular response. You can consider this post to be something like a stand-alone education on empirics and modern Economics in the event I don't find my way to the reply button.

Mar 18, 2011, 5:01 PM

It's easy for Austrian thugs like yourselves to harp on Matt and others for "not knowing anything" about ABC theory. I, however, have studied the matter evidently much more than yourselves, and in fact I have studied every business cycle theory more than yourselves, because besides the fact that such matters deeply stimulate me intellectually, mastery is required for my Economics degree.

Mar 18, 2011, 5:12 PM

" because besides the fact that such matters deeply stimulate me intellectually, mastery is required for my Economics degree."

So you don't have that degree yet?

Mar 18, 2011, 5:50 PM

Writes Chris:

Before I begin I would like to point out that if either of you actually knew anything about ABC [Austrian business cycle] theory, you would know that it directly implies market economies are inherently sub-optimal and flawed.
Flawed? Compared with what alternative? Those who propose dirigisme (of whatever kind) are quick enough to gripe about lags in the operation of feedback mechanisms in the free market while evading address of the ways in which top-down normative interferences not only impose far more wasteful misallocations of resources but also become tenaciously entrenched by way of political rent-seeking.

I find it hilarious that Chris should condemn the Austrian school for having divorced "itself from mathematics, history, and data analysis in general" when Chris writes that "when almost all of the influential Austrian ideas were formed, 'The Fed' as we know it today simply did not exist (1913 was well after the von Mises analysis)."

Chris obviously doesn't realize that central banking had been operating in Europe for some several centuries (as well as in these United States throughout the 19th Century), providing the first representatives of the Austrian School with plenty of history upon which to predicate their conclusions regarding the invidious effects of currency debauchment.

That econometric prestidigitation is unnecessary to make sense of historical phenomena would be obvious to anyone whose intentions are not duplicitous. The purposes of accurate measurement and valid statistical analysis are to refine the appreciation of how things have happened, and can be expected to happen. Not to handwave acknowledgment of objective reality out of consideration.

As for the fact that "The field was known as 'political economy' at the time" just what the devil gives Chris to conclude that it's not still properly to be called "political economics"?

What we're talking about here is not the kinds of budgeting which go on in the operations of a business or a farm or a household, but rather the effects of government officers purposefully intervening in the market activities of private parties conducting voluntary truck and barter of various kinds.

In the case of central banking - "fiscal policy" - those government officers are diddling the currency to manipulate prevailing interest rates while thieving away the purchasing power of the money in people's pockets.

If that's not "political," what is?

Mar 18, 2011, 9:07 PM

Wow, this is ridiculous. Matt has one sentence in a 5 page article dissing Austrians and all of a sudden he's an ignoramus?

Can you guys point out what it is that is so "embarasing" about this article?

Mar 19, 2011, 1:33 AM

This is exactly why nobody in academia listens to Austrians, they present themselves constantly as obnoxious internet trolls, as demonstrated by this comment section.

Mar 20, 2011, 12:04 PM
Richard Allan:

The funniest thing about this article is how Matt never mentions how exactly monetary stimulus is supposed to boost output. At Uni we were taught that it does so by suppressing real wages. So if "progressives" are supposed to support the suppression of real wages in this instance for the sake of unemployment, why would they support a whole panoply of policies designed to do the opposite in every other instance?

Also, of course no mention is made of the possibility of moral hazard - the expectation that the Fed will counteract velocity shocks in itself causing the likelihood of those shocks to increase.

Mar 20, 2011, 2:02 PM

You offer the conventional analysis: that the Fed (implicitly treated as outside the economic system) *operates on* the economic system by putting money in or taking it out. "[The Fed's] [p]urchasing bonds puts more money into the economy, creating conditions of 'easy money', and is known as 'easing'. Selling bonds makes money 'tight' by pulling it out of the economic system."

But, inconsistently, you say that the Fed also operates on the system merely by *announcing its intention* to buy or sell bonds. Market participants, believing that the Fed will carry out its announced intentions, then drive bond prices up or down, as the case may be (short-term interest rates going down or up, respectively), by private actions in the market. And so, you say, the Fed actually has to *do very little* buying or selling of bonds; private market participants do the work for the Fed. This assumes that the Fed's job is not to control the quantity of money but to *control (short-term) interest rates*: for an announcement from the Fed, while it may *affect rates*, does nothing to *alter the quantity of money*.

So, what is the Fed's basic mechanism for controlling the economy: manipulating the quantity of money, or manipulating short-term interest rates?

Mar 20, 2011, 4:12 PM

It seems to me that we have yet to see progressives admit their failure to understand economic theory and to see them keep pushing the failed thinking that has created crisis after crisis as the nation has been sliding towards the abyss.

Instead of pandering to power, Matthew Yglesias should ask why it was only Ron Paul who predicted the crisis during the last presidential election while fools like Romney, McCain, Obama, and Clinton failed to see the crisis coming. Why was it that the mainstream financial commentators failed to see what the Austrian economists saw as the inevitable end of misguided policies and why is Mr. Yglesias giving those incompetent commentators the contempt that they deserve for failing the members of the public who were dumb enough to believe them knowledgeable?

As an outsider who was looking at the US elections with a great deal of interest it is hard for me to feel sorry for American voters because they chose the path that will lead to hyperinflation and the destruction of their own currency. Instead of backing the one candidate who had a grasp on economics they overwhelmingly voted for statists from both sides of the spectrum. That Mr. Yglesias spends so much of his time and energy attacking Dr. Paul and the Austrians suggests that he understands that they are not as marginal as they used to be and that the time of the statists being in control may be drawing to a close.

Mar 21, 2011, 8:39 AM

"So, what is the Fed's basic mechanism for controlling the economy: manipulating the quantity of money, or manipulating short-term interest rates?"

Both. The Fed has many ways to influence the economy over the short term. What it cannot do is perform the function of a free market and as such is always a net negative on the economy. The Fed needs to go if the US is to recover. History has shown that the central planners that Matt seems to favour have always failed miserably. It is not different this time around.

Mar 21, 2011, 8:49 AM
Steve Roth:

Demand Inflation Now!

Mar 21, 2011, 11:31 PM

Bullshit. The job of the Fed is, and has always been, is inflating the currency to maximize the profit of the banks that own it, and enable profligate spending by the government. Any other ostensible purpose of the Fed is nothing but propaganda.

I think that this is a sensible observation. Everyone responds to incentives and when given the power to enrich oneself and ones friends by creating purchasing power out of thin air it should not be surprising to any rational person that the power is used for that purpose.

Mar 23, 2011, 5:11 PM

By way of for the benefit of the insensate lovers of the Federal Reserve:

"The Federal Reserve has existed for almost 100 years and it has created depressions, recessions, inflation, and bubbles. This CF&P Foundation video explains the origin of central banking and mentions possible alternatives that will be discussed in subsequent mini-documentaries."

Mar 25, 2011, 12:16 PM
lea cox:

Federal reserve is not federal nor has reserves to begin and they way it was arranged by 4 poweful banks, speaks for itself.
Just another way to enslave Americans in pay interest through their noses and never really own anything. Someone like wall street or mergers or others will make sure you stay poor.Why does a mortgage have high interest in the front/ Why not simple interest, half to the bank and half to principal to start with...compute please and take in to account that americans move a lot buying new houses and starting all over again. Hardly they make a profit unless the house is bought real cheap, deals can be made by few.
being the housing industry one of the largest and prices always going up and not regulated, that is how they become billionaires and we are still holding the bag 30 years later.. who decided the mortgage has to be amortized for 30 years? The banks?
It is a scam and people accept it as the norm.

Mar 28, 2011, 2:28 PM
David Conrad:

It seems like most of the Austrians didn't bother to read past the third paragraph.

Mar 30, 2011, 3:17 PM
Pat Evans:

No one ever wants to talk about who owns the Fed. Why? Is it because we are paying our debt and letting foreign banks control our currency? Why don't we discuss that? Seems like a big deal to me!
7 of 12 are foreign
1. Rothschild Bank of London
2. Warburg Bank of Hamburg
3. Rothschild Bank of Berlin
4. Lehman Brothers of N.Y.
5. Lazzard Brothers of Paris
6. Kuhn Loeb Bank of N.Y.
7. Kuhn Loeb Bank of Germany
8. Israel, Moses, Seif Banks of Italy
9. Goldman Sachs of N.Y.
10. Warburg Bank of Amsterdam 11. Chase Manhattan Bank of N.Y. 12. Rockefeller Brothers of N.Y.

Don't you feel it's logical that these banks are looking out for their own interests? These are some very well connected institutions not to mention that old moneyed elite. Is it any wonder that the US government is seen to be pandering to the rich and the country has turned into an oligarchy? Make sense now?

Apr 10, 2011, 2:13 AM

In a 1999 interview, Nobel Prize winning economist and Stanford University Professor Milton Friedman stated: "The Federal Reserve definitely caused the Great Depression." They also caused the Clinton .com boom and bust and the real estate bubble.

Aug 21, 2011, 1:14 PM
Some guy:

It's always seemed that the Fed exists as the bridge between government and private enterprise.

Would it be better to have government solely control the monetary supply? Looking at Europe, perhaps not.

The Fed is a compromise and whilst it does not work perfectly, it has gotten us this far. Maybe it needs a bit of pruning every now and then, but it is not the anti-Christ.

And the idea of accountability for the Fed is rather boorish. Certain positions require true independence from performance. Judges. Central bankers. People that make difficult decisions. If you had a Fed that was driven by 'quarterly results' my god we would be Argentina for a fifth time by now.

This is the first article I have read by the author and I think it will also be last.

Good day.

Jan 10, 2012, 4:12 AM
Israel Investigations:

Respecting the dedication you put into your site and detailed insight you provide here. It's very good to discover a blog in a rare occasion that is not all the same outdated rehashed material. Fantastic work! I've saved your site and I'm including your RSS feed to my Bookmarks now. Even more, I appreciate your blog so much that I want to advertise my own site on yours. I would appreciate you email me at: everythingrainbowhk (AT) listing your quarterly ad prices. Much appreciated!

Feb 14, 2012, 11:05 PM
Mark T:

I'm amused that the writer finds significance in Time magazine puffing up Bernanke. They put Larry Summers, Robert Rubin, and Alan Greenspan on the cover and pronounced that they had "saved the world". As Frontline showed in their feature about Brooksley Born, they're the ones who really caused the situation that resulted in the TARP bailout in the first place. Taibi at Rolling Stone has been covering this, I don't expect he'll be getting any prizes though; as he is as pissed as most of us, the articles have a lot of f-bombs.
Relax. The whores in the House will never let Paul have his audit of the Fed. Too bad, it would be interesting to see where all that money really goes.

Jul 9, 2012, 3:37 AM
dave krueger:

We are all in this together.
Y'all sound like a bunch of teenage mothers pissed off that's it's laundry day!

Dec 3, 2012, 7:31 PM

Post a Comment



Comments (you may use HTML tags for style)


Note: Several minutes will pass while the system is processing and posting your comment. Do not resubmit during this time or your comment will post multiple times.