Everyone is worried about inflation. The year-on-year price increase reached 5% in May. Market watchers and financiers are on red alert. Ted Cruz recently warned in these pages about the disastrous aspects of a depreciating dollar. As prices start rising faster than wages, many people are wondering how they will meet their needs.
Strange as it may sound, however, inflation is a smokescreen. It is covering far more serious problems in the economy. Those problems stem from the fact that the Federal Reserve, our central bank, acts as a law unto itself. As I, Peter Boetke and Daniel Smith argue in our new book, money and the rule of lawAmericans won’t be blessed with financial stability until the Fed holds the reins of Congress.
Inflation is less worrying than expected as it is likely to be temporary. The combination of exceptional monetary policy, massive fiscal stimulus, and sluggish pandemic constraints means we have plenty of purchasing power to chase down enough goods. This situation will ease as the economy continues to improve. Those willing to bet on their faith are not worried about inflation: the market currently expects inflation to be around 2.5% per year for the next five years. This is hardly a recipe for an economic slowdown.
Much more related than inflation is the changing role of the Fed. In the wake of the COVID-19 crisis, the Fed acquired extraordinary new powers. For the first time, our central bank offered direct loans to large non-financial corporations. The Fed also bought corporate loans in the secondary market from firms such as Coca-Cola and Berkshire Hathaway, which had nothing to do with the stability of the banking system. The Fed advances the debt of state and local governments with a history of fiscal negligence. It was about politics, not economics.
Finally, the enormity of the Fed’s activities has turned it into one of the biggest players. Its balance sheet stands at just $8 trillion, up from $4 trillion before the pandemic.
The combination of rising assets and preferential credit allocation means the Fed is picking winners and losers. The whims of bureaucrats have replaced market discipline. This is a real threat to our economic well-being. We need serious Fed reform to ensure that the central bank remains an agent of economic stability rather than political patronage.
Only Congress can fix what’s wrong with the Fed. The central bank’s current mandate is to pursue full employment, stable prices and medium long-term interest rates. It is very broad. Since members of Congress are generalists and central bankers are experts, the former often lack the expertise to supervise and the latter to police. We need to limit the mandate of the central bank, replacing it with something more specific and verifiable.
Economists widely agree that with monetary policy, rules work better than discretion. The economy is too complex for the Fed to micromanage. The best it can do is set the broad conditions for economic stability. The Fed’s current rule, targeting 2% inflation in the long run, looks good on paper. But the rule itself is adopted, which means the Fed can stop following the rule whenever it wants. A rule that does not bind is not a rule.
It is time for Congress to step in and choose a specific target for monetary policy. The Fed can and should be free to choose the instruments it uses to achieve that goal. But the goals of monetary policy are precisely the concern of the people’s representatives in Congress. This is the only way we can make monetary policy democratically accountable.
Alexander William Salter is an associate professor of economics in the Rawls College of Business at Texas Tech University. He is the author (with Peter Boetke and Daniel Smith) with money and the rule of law. He wrote this column for The Dallas Morning News.