Editor’s note: A longer version of this article first appeared at Forbes.com.
On Dec. 23, 1913, President Woodrow Wilson signed the Owen Glass Act, creating the Federal Reserve. Looking back, what has the Fed accomplished during the last 100 years?
The stated original purposes were to protect the soundness of the dollar and banks and also to lessen the jarring ups and downs of the business cycle. Oops.
Under the Fed’s supervision, boom and bust cycles have continued. Three of them have been severe: the Great Depression, the stagflationary period of 1974-82, and the current “Great Recession.” Bank failures have occurred in alarmingly high numbers. Depending on what measurements are used, the dollar has lost between 95 and 98 percent of its purchasing power. (Amazingly, the Fed’s official position today is that inflation is not high enough, so the erosion of the dollar continues as a matter of policy.)
Having failed to achieve its original goals, the Fed also has had a miserable record in accomplishing later goals. The 1970 amendments to the Federal Reserve Act stipulated that the Fed should “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” In baseball parlance, the Fed has been “0-for-three.”
First, the premise that the central bank can “fix” unemployment is erroneous. It is based on the Phillips curve—the discredited academic theory positing a trade-off between inflation and employment. Unemployment is fundamentally a price problem, not a monetary problem; therefore, the cure for unemployment is a free market in wages, not any particular monetary policy. The Fed’s current policy of persisting in “quantitative easing” until the official unemployment rate reaches a targeted level is the wrong medicine.
Second, central bank tampering with interest rates is the fundamental cause of, not the cure for, the boom and bust cycles; thus, the Fed should cease from tampering with interest rates.
Finally, focusing on “stable prices” is looking at the problem backwards. The Fed shouldn’t try to influence prices any more than a nurse should influence the readings of a thermometer. The “fever” that causes prices to rise and purchasing power to fall is sick money. “Heal” the money (i.e., do away with a fiat currency and abolish fractional reserve banking) and prices will take care of themselves.