Over the past few months, I’ve discussed the politicization of macroeconomic policy. Geithner’s demands for China to raise rates are certainly troubling. Unfortunately for him, bully-boy threats seem to be paying few dividends in international monetary policy. But now Geithner claims that congressional leaders who want monetary policy to focus on price stability instead of full employment are politicizing the Fed as well.
At first blush, the claim seems hard to deny, but it really isn’t. In fact, one could argue that a focus on price stability would reduce the politics behind monetary policy. Further, the academic literature does not warn against all politics in monetary policy. It simply warns against politics deciding interest rates and the money supply (like Geithner’s prodding of China’s rates). Essentially, don’t let politics decide the speed of the printing press. Bernanke, a well-respected academic, should fully understand this distinction.
There’s nothing wrong with a bill that redirects the Fed toward price stability. Plenty of central banks have taken the same steps. The Fed could still dictate monetary policy as it sees fit.
Further, we have a clear example with the European Central Bank, which primarily focuses on price stability. Would it radically politicize the Fed to adopt a sensible ECB policy? I think not. In fact, the European Central Bank in many ways reduced politics in central banking with this policy as well as others. Previously, European governments could spend like crazy and finance themselves through a printing press. But with the creation of the ECB, monetary policy was placed into the hands of several countries, instead of only one.
Unfortunately for the ECB, they didn’t get rid of all political problems. Sure, a country couldn’t print a bunch of euros by itself. But this doesn’t mean that the country wasn’t going to run itself into the ground anyway – hence the bailouts. But even here, there is an important advantage to the ECB system. Numerous countries must decide whether to bail out the PIIGS and by how much. The countries in trouble don’t decide alone.
Similar systems and problems already exist in the U.S. Think about California as an example. Every American is extremely fortunate that California is not allowed to print its own U.S. dollars. If they could, the dollar would be going through hyperinflation by now. The fact that other states must ultimately bail out California is the last restraint on this bureaucracy gone mad.
Changing Fed goals can have negative consequences – but not because it’s a politicization of the money supply. Politicians will not decide interest rates. With price stability as the key goal, things may even be less political. After all, the unemployment rate is inevitably tied to the fates of many congressmen and the president. And as a short-term monetary stimulus can reduce unemployment, it’s impossible to ignore the political significance of targeting the unemployment rate. On the other hand, price stability isn’t a political issue unless serious inflation takes hold. No one is going to call their congressman because the inflation rate is 3.5% instead of 2.5%. But if unemployment doesn’t change by a single percentage point this year, there will be some very unhappy constituents out there.
In the past few years, the Fed has become much more powerful. Where was the Treasury to warn us about the dangers of politicization then? The very fact that politicizing the Fed is only mentioned when the Fed’s powers are threatened lets you know exactly how political monetary policy has already become.
