Burrowing Owls. Photo: Tania Thompson. Source: Shutterstock
For most people, the Federal Reserve is a mysterious place that makes mysterious hooting sounds every few months, and they tell banks where to set interest rates. Academics and politicians rail at the Fed for various reasons, but their debates often sound like medieval scholastics debating how many angels can dance on the head of a pin: irrelevant to our everyday lives.
But the Fed is an essential part of our financial infrastructure – a banker’s bank – that keeps things going when there’s a crisis of confidence. It was created 100 years ago because a modern economy needs a central monetary authority. Banks are subject panics and runs. That’s the way finance works. If everyone pulls their money out of the banking system, the economy grinds to a halt. It’s like the military: the expenses seem excessive, until you really need them.
Calls to end the Fed are fundamentally misguided. If the Fed hadn’t backstopped the financial system in 2008, we would have entered another Great Depression. We know the Fed is subject to a “knowledge problem”: the information officials need to set policy is dispersed among bankers and asset managers and corporate officers and consumers. Aggregating this data obscures what the Fed needs to know. But this is an issue for managing the system, not for pulling it up by the roots. Every bureaucratic organization faces a knowledge problem.
A modern economy, with trillions of dollars in daily, global money flows, needs a central authority backed by the national treasury. There is no alternative. When a high-profile failure shocks the economy, some authority must be able to step in decisively and restore faith in the system. Otherwise we will see the “Paradox of Aggregation” in practice: each of us acts in our own rational, private interest and creates an irrational, public problem.
Global Central Bank Assets. Source: Yardeni.com
The Fed should be modest in its goals and open about its operations. Shooting for stable prices and a sound banking system is enough for any agency. It shouldn’t try to micro-manage the economy. No one can do that. It needs to be transparent and accountable, because every public institution needs public accountability. We all need to be accountable. But the last thing any central bank should have is a bunch of politicians looking over its shoulder publicly criticizing the latest decision.
Because driving down the road with 535 back-seat drivers in Congress isn’t just distracting, it’s dangerous.
Douglas R. Tengdin, CFA