How to Fix the Fed

John Tatom

No 80, Studies in Applied Economics from The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise

Abstract: Congressman Jeb Hensarling (R-TX) introduced the Financial CHOICE Act to reform the Federal Reserve in late 2016 and is expected to resubmit it early in the new session of Congress. Its key monetary policy focus is on imposing a monetary rule on the operation of the Fed. This is a worthwhile effort, like its many other admirable features, but it does not address the Fed’s asset powers or its new ability to pay excessive interest on reserves, which over the past eight years have allowed the Fed to inflate its balance sheet, and to do so without little effect on monetary aggregates. Just as the Fed caused the Great Recession by stagnant growth of its monetary base, its expanded powers since late 2008 allowed it to prolong the recession and stifle the recovery and expansion while appearing to provide explosive stimulus. The Fed focused on expanding its credit and expanding its lender-of-last-resort function while restraining the growth of monetary aggregates and bank credit. The Fed has not acted in such a counterproductive manner since October 1931, when it raised the discount rate in the midst of the Great Depression. Without a focus on money, adherence to an interest rate rule will not be effective in achieving low inflation and monetary stability.

Pages: 6 pages
Date: 2017-04
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