Editor's Note: This columns was written by David Schwartzman.
The Federal Reserve quietly controls the economy. In their new Monetary Policy Report, the Fed says more interest rate hikes are on the way, and our entire economic system teeters in the balance. Markets intensely watch its every move, and with good reason: the Fed has made devastating mistakes before. Former Chairman Ben Bernanke admitted in 2002 that the Federal Reserve’s actions created the Great Depression. In the 1970s, Federal Reserve policy led to stagflation––high inflation and high unemployment. We trust the Federal Reserve to set the price of money through the interest rate. But based off of their track record, we shouldn’t. For a healthier, freer economy, Congress should take the economy out of the Federal Reserve’s hands and put it back into our own by reinstating a free market for money.
When the Fed creates artificially low interest rates like it has for the last nine years, it causes an artificial boom that inevitably leads to bust. The low interest rates induce businesses to begin long-term projects. In a free market for money, low interest rates indicate that more people are saving, leaving them money to spend in the future. However, with artificially low rates, saving is discouraged. This means that the economy does not have the necessary savings to complete long-term projects. Resources are wasted.
The price of money is a vital part of the economy, as money is the way we determine the value of goods in relation to each other. Money injected by the Fed is not spread equally throughout the economy. Instead, there is an injection point. Prices go up more closer to the injection point, which shifts the value of goods relative to each other. This distorts price signals.
At their core, markets are about providing information through prices. When the Federal Reserve distorts the price system, we lose vital information about the world around us. When individuals react to changes the in the economy caused by the Fed, they get false signals about what consumers want. We don’t know if resources are being used the way people want them to be used. As a result, we waste them.
The Fed’s injection of money also redistributes wealth from the poor to the rich. Federal Reserve actions put money in financial markets through their manipulation of the bond market and their purchases of financial instruments. Since more money lowers the value of each existing dollar, those outside the financial industry are harmed. The Fed’s response to the last recession protected the well-off at the expense of everyone else. Federal Reserve actions promote income inequality.
In theory, these serious defects are the necessary price for the Federal Reserve’s ability to stabilize the economy. However, the Federal Reserve has repeatedly failed to this because it
faces too many obstacles. To manage the money supply, the Fed needs to collect data about the economy and model this data to recognize the true state of the economy. Often, the Federal Reserve is wrong. Even if it’s not, the economy is constantly changing in unpredictable ways. By the time monetary policy takes effect, the economy it was designed to fix no longer exists.
Without Federal Reserve interference, individuals and businesses can react to market conditions freely and effectively. Most economic problems are about rapidly adjusting to changes in a specific set of circumstances. Those directly involved should be making planning decisions, not the Federal Reserve. Individuals can decide how their needs change in tough times. Businesses can determine what goods to make and how much consumers want them. While not everyone has the same knowledge of specific situations, prices on the free market coordinate actions. When the Fed toys with the price of money, this process cannot function correctly. It is no wonder that recovery from the 2008 recession has been characterized by putrid growth.
The economy is an intricate and complex system. It is too complicated for the Federal Reserve Board of Governors to effectively set the interest rate. The Fed creates waste and income inequality and interferes with economic growth by trying anyway. Congress should recognize this by removing government from active involvement with money.
David Schwartzman is a Policy Research Fellow at the California Policy Center. He is a rising senior studying economics, mathematics, and finance at Hillsdale College.