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But the profound effects of the Fed’s avowed purpose—manipulating interest rates and making paper currency—are damaging enough, at least for those who see its fingerprints all over the current crisis, to make more baroque conspiracy theorizing superfluous. And when it comes to mistrusting the Fed, the Alex Jones crowd is not alone.
We’re All Austrians Now
Economists, pundits, and financial analysts are not exactly gathering by the hundreds in front of Federal Reserve buildings and chanting “End the Fed!” But it has become almost impossible to avoid respectable voices in respectable venues laying some of the blame for the economic crisis at the Fed’s discount window.
The Berkeley economist Brad DeLong, a popular blogger and former Clinton Treasury Department official who once dismissed Mises’ general monetary theory as “batshit insane,” still told this story in the October 2008 issue of the liberal American Prospect: “The current financial crisis has its roots in Greenspan’s decision to keep interest rates very low in 2002 and 2003 to head off the danger of a deflation-induced double-dip recession.…Six months ago, I would have said that his judgment was probably correct. Today… I can no longer state that Greenspan made the right calls with respect to the level of interest rates and the housing bubble in the 2000s.”
Fed bashing in a roughly Austrian style has gotten so popular that the theory’s opponents now feel embattled. Scott Sumner, a monetary economist at Bentley University who writes the much-cited blog The Money Illusion, thinks the Federal Reserve was and is too tight with interest rates and money for optimal economic performance. “As everyone knows by now,” Sumner complained in June, “the once kooky and discredited Austrian business cycle model has now become conventional wisdom.”
Blame-the-Fed sentiment now stretches across the spectrum of economic thought, from Keynesians such as DeLong to monetarists (who generally want the bank to maintain a fixed rate of money supply growth). In October 2008, the monetarist Anna Schwartz, co-author with Milton Friedman of one of the most important books of monetary economics, A Monetary History of the United States, told The Wall Street Journal: “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object.”
In February 2009 the Stanford economist John Taylor, a monetary whiz so influential that there is a rule for setting interest rates named after him, told The Wall Street Journal: “The Fed held its target interest rate, especially in 2003–2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust.”
Even the Obama administration has gotten into the act. “Monetary policy around the world was too loose too long,” Treasury Secretary Tim Geithner told PBS interviewer Charlie Rose in March. “And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”
As with any issue in political economy, there’s disagreement. There are a variety of arguments to parry or blunt the Austrian theory. Former Federal Reserve Board economist Arnold Kling, for instance, argues that the modern world of money and credit is so convoluted, with so many avenues for the creation of money-like instruments outside of direct Fed control, that the Fed shouldn’t be seen as the main villain in any credit-driven collapse. At worst, Kling thinks, it’s a hapless bungler pretending to power it can never have. Bryan Caplan, a libertarian economist at George Mason University, thinks people are generally too smart to be fooled enough by false interest rate signals that they precipitate an economic crisis.
And pinning even partial blame for the current economy on the Fed is different from questioning its legitimacy. By limiting his bill to the narrow question of transparency, Paul is making it possible to create a broad political coalition that can agree the Fed needs to be kept in check without necessarily agreeing on why, or on what the Fed ought to be doing.
The Fed Forever?
Despite the palpable momentum behind H.R. 1207, the idea of inconveniencing the Fed with anything more severe than an audit still seems like a far-off fantasy. Meltdown author Woods notes that, although many mainstream analysts are jumping on the Austrian bandwagon to explain the causes of the crisis, none of them are really embracing the Austrian solution of ending the Fed’s power to manipulate interest rates at will. They just call for the power to be used more prudently next boomtime.
The Fed was an ideological and institutional response to a convincingly told story of crisis and solution—basically, that the 19th-century system of mostly private banks issuing their own mostly gold-backed paper was leading to too many small economic crises of the sort that used to be called “bank panics.” Milton Friedman, a critic of central banking practice, at the same time dismissed attempts to return to a commodity standard such as gold. One of his reasons was that it was “not feasible because the mythology and beliefs required to make it effective do not exist.” But with best-selling books, activists in the street, members of Congress, and economists across the ideological spectrum casting aspersions on Fed practice, we may see the crafting of a new set of myths and beliefs.
In this time of political ferment, Stephen Axilrod, a longtime Federal Reserve staff director and monetary policy guru, has issued a memoir from MIT Press titled Inside the Fed. Axilrod admits that Fed interest rate actions precipitated the crisis without letting that fact dent either his admiration for the institution or his belief in its necessity. Still, Axilrod notes something that should encourage Fed skeptics of all varieties: that “a country’s monetary policy is almost necessarily limited by conditions generated from the political, philosophic, and social ethos of the time.”
We are now seeing attempts to move the ethos in an anti-Fed direction. While it’s hard to imagine an America without an institution that has become so central, it’s interesting to contemplate something former Rep. Eldridge Spaulding (R-N.Y.) said in 1868, in the midst of the legal controversy over Civil War greenbacks: “No one would now think of passing a legal tender act making the promises of the Government…a legal tender in payment of ‘all debts public and private.’ Such a law could not be sustained for one moment.”