OPINION:
Unless they have a special interest in macroeconomics, most Americans may not know that the Federal Reserve wasn’t created to conduct monetary policy. In fact, the Federal Reserve Act of 1913 doesn’t mention it.
Initially, the Fed had one fundamental aim: to rectify repeated waves of financial panics and bank runs. Toward this end, the nascent Fed was empowered to make loans to banks to address short-term liquidity needs and to make the supply of currency more “elastic” or tolerant to fluctuations in demand by creating and dispersing a new national currency: the Federal Reserve Note.
Yet, today, the Fed has strayed far from its initial charge of stabilizing the banking system. Increasingly empowered by Congress in the years since 1913, the Fed is now charged with a “dual mandate” to maximize employment and stabilize prices.
To achieve those goals, the Fed employs a strategy of interest rate targeting. The problem is that interest rate targeting is tantamount to a price control and the Fed needs to end this strategy for many reasons.
First, we know price controls are wrongheaded and counterproductive because they distort the clarity of price signals that convey powerful, diffuse information regarding what to do and how to do it. We don’t like price controls for gas because we know what we get: long lines and “out of gas” signs.
The same is true with so-called “anti-price gouging” laws. Remember hopelessly looking for toilet paper and hand sanitizer during the COVID-19 shutdown?
We don’t like minimum wages because they reduce employment among the very individuals they presumably help, and we don’t like rent control because we end up with less housing, less-attentive landlords and units occupied by the well-connected who can afford to pay bribes and work the system.
In short, price controls make it harder to make sensible choices because they distort the incentives that would otherwise be in place and the decisions we would otherwise make. So why have we outsourced the most important prices of all in a dynamic, capitalist economy interest rates to a price-control board called the Fed?
Second, in a dynamic, growing economy, interest rates provide valuable guidance to households regarding how much to save, when and over what time horizon.
The demand for these households’ hard-earned savings is driven by entrepreneurs who want to borrow their money to finance projects that can’t be accomplished overnight. Some firms need to borrow significant sums, while others need less. It’s hard for these savers or entrepreneurs to be good stewards if interest rates are distorted by policymakers.
Third, in a world where interest rates are artificially kept at rock bottom there is no incentive for households to save at all. Why should I save anything if the return is terrible? In fact, I might as well buy stuff on credit instead of out of my savings if interest rates are low. Artificially low interest rates disincentivize all families from saving because they turn Ben Franklin into a fraud a penny saved becomes a penny you might as well go ahead and spend.
Finally, it’s actually quite backwards to authorize the Fed to do what it must to achieve maximum employment and price stability. These are important measurements because they are the vital signs of a healthy and robust economy and would be natural outgrowths of a society full of opportunity. Ironically, the best way to maximize employment and stabilize prices would be for the Fed to do an about-face from its current approach and stop interfering with the free market.
In short, interest rates should not be dictated. Just like other prices, they should be driven by us. Our intentions, actions, callings, and time preferences are capable of coordinating financial markets just like they do in any other market.
For centuries, Thomas Aquinas and other Christian scholars have marveled at the price system’s ability to order human interactions and relationships. This includes all prices, including prices of loans, direct human potential and decision making. Just as German astronomer Johannes Kepler was alleged to sing songs of praise when he considered the ordering of the universe, economists should probably be singing, too, in wonder at the unseen ordering of markets.
To continue entrusting interest rates to the Fed presumes that it does a better job of coordinating human action than we ourselves can, in the absence of their artificial rates.
I don’t believe it, and you shouldn’t either.
• Victor V. Claar, PhD, is associate professor of economics in the Lutgert College of Business at Florida Gulf Coast University, an affiliate scholar of the Acton Institute and a visiting research fellow at the American Institute for Economic Research.
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