Tuesday, March 8, 2011

Federal Reserve: A Bad Idea?

As the Federal Reserve System approaches its 100th Anniversary, some of the nation’s leading economists who study the Fed converged on Wake Forest University to debate the success, failures, and relevancy of this central bank and its monetary and regulatory policies.

“The Federal Reserve Was a Bad Idea” conference held on February 11-12 was organized by the Economics Department at Wake Forest University and sponsored by the BB&T Center for the Student of Capitalism in the Schools of Business.

Professor Page West, director of the BB&T Center for the Study of Capitalism, said the conference addresses topics that are very timely and relevant to all Americans. "There is a significant debate going on today about the real impact of the Fed's policies to shore up financial institutions, help the economy grow, and keep inflation under control,” he said. “Intelligent people line up on both sides of the issue. So what can we learn from the history of central bank efforts and effects in the U.S.? That is the focus of this conference."

To explore these historical perspectives and suggest answers to current questions, 70 economists from U.S. universities and representatives from policy think tanks converged on Wake Forest for the 2-day conference.

One of the best-received presentations was given by Professors George Selgin of the University of Georgia and Lawrence White at George Mason University. Their historical analysis finds "The Fed‘s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed‘s establishment."

Read more after the video.

One keynote speaker at the conference was Professor of Practice at Wake Forest University Schools of Business, John Allison. In his 20-year tenure as the CEO of BB&T, Allison became quite familiar with Fed monetary and regulatory policies. He presented a “banker’s view of the role of the Fed.”

Allison asserts that mistakes by the Federal Reserve in managing the money supply and interest rates, combined with the affordable housing policies of Freddie Mac and Fannie Mae (the giant government sponsored housing finance enterprises) were the cause of the massive misinvestment in residential real estate that created the recent financial crisis.

Much of Allison’s presentation focused on a criticism of regulations. “Many regulations are probably unconstitutional because they are so broad,” Allison said. “Regulators effectively make laws. Regulations are in fact implemented very unevenly over time and in relation to individual institutions.” He cited a series of laws passed during his tenure in the banking industry and provided examples of instances in which he observed politically-motivated implementation.

Wake Forest University Professor of Economics John Wood explored the effects of the replacement of the Independent Treasury by the Fed, especially during the Great Depression. He posed the question, “Which produces better policy: close congressional oversight, including debates over controversial actions, of the monetary authority, or an expert independent agency outside Congress’s attention?”

Wood argued that the Depression of 1929-1933 may have been worsened by the increase in monetary policy’s independence of Congress. “The Fed failed to take account of the dependence of bank borrowing on economic activity. Money and prices fell by a third between 1929 and 1933, more than 10,000, or 40 percent of banks, failed, and not even an unemployment rate of 25 percent called forth an expansionary monetary policy,” Wood said. “The Fed failed to understand the system for which it was responsible, and the great distance from the costs of its mistakes prevented it from reacting to the problems of the victims.”

However, Wood questions whether the Independent Treasury would have been more effective. “It is difficult to imagine that the government’s control of the currency would not have increased even without the Federal Reserve. We have seen that the Independent Treasury powers had been expanding.”

Wake Forest Professor of Economics Dan Hammond attempted to answer the question of what the late Milton Friedman, one of the 20th century’s most influential economists and an advocate of free-markets, would say about the Fed today.

Friedman argued that the Fed had been a source of monetary instability through most of its history. In the 1980s, he argued that Congress should take monetary policy away from the Fed, freezing the monetary base, and thus ending what he called the Fed’s “arbitrary power” to determine the nation’s money supply, Hammond said. The public today, he added, would be better off understanding the lesson Freidman learned through his research on central banking. This is that policy makers and politicians have little ability to effectively manage the economy.

“We can be sure that events over the past four years would be cause for reconsidering his appreciation of Alan Greenspan’s tenure at the Fed, and that he would decry the capricious innovations in Fed policy that we have witnessed,” Hammond said. “Friedman would not look favorably on power wielded in an arbitrary way by unelected officials. But whether we would be better off without the Fed depends very much on the alternative.”
Over the two days, more than 100 Wake Forest students attended the Federal Reserve Was a Bad Idea Conference.

White papers from the presentations can be found here. Click here to watch a video of the keynote address presented by Professor Thomas Sargent, New York University.

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