Maintaining the Value of the DollarCommentary by Pete du Pont
December 20, 1995
Article I, Section 8 of the Constitution gives Congress the power "to coin money [and] regulate the value thereof."
Nowhere does the Constitution tell Congress how much money to coin, how it should be valued, or how the government should regulate these matters. In 1913, the Congress gave the power to decide those issues to the Federal Reserve, which quickly became - and still remains - the most powerful economic institution in the nation.
As our nation's central bank, the Fed decides how much money will be available in our banking system to make loans. So in addition to controlling the money supply, it largely controls short-term interest rates. With control over the money supply and interest rates, the Fed then has enormous influence over real economic growth, unemployment, and inflation in our economy.
Most people know little - and care less - about monetary aggregates, discount rates, and other technical Fed issues. But every American understands that a primary responsibility of the government is to maintain the value of our money. A government that intentionally (or even unintentionally) erodes the value of earnings and savings is undermining current prosperity and the future prospects of its citizens. Along with establishing justice, ensuring domestic tranquillity and providing for the common defense - to quote the preamble to the Constitution - sound money, a dollar "as good as gold," is the ranking economic priority of the nation.
The trouble is, that's not what the law says. The Employment Act of 1946, as amended by the Humphrey-Hawkins Act of 1978, legally sets "full employment" as the primary goal of Federal Reserve policy. This law requires the Fed to stimulate the economy with lower interest rates and the coining of more money whenever the unemployment rate rises.
Of course these two actions can quickly lead to higher inflation, which devalues our money. Nevertheless, whenever unemployment rises, even when inflation is already too high, the Fed is legally required to stimulate the economy. So inflation ratchets higher and higher, until a recession occurs and moderates the inflation.
Such economic cycles roll through our economy much as weather fronts roll across the country. But unlike storms, economic cycles build upon each other. History has often seen that both at the trough of each new recession and at the peak of each cycle of expansion, inflation and unemployment were higher than they had been the time before.
So there is a "catch 22" in which higher inflation leads to higher unemployment. Then under the Humphrey-Hawkins rule, the higher unemployment requires additional Fed stimulus, which in turn leads to even higher inflation. These kind of cycles and pressures hinder the Fed's long run ability to maintain the value of our money. As long as the Humphrey-Hawkins law remains unchanged, the value of our savings remains at risk.
Right now inflation is under control, and unemployment is low, so the Fed faces no dilemma. But sooner or later the Fed will again face that hard choice of whether to obey the law and temporarily reduce unemployment at the cost of higher inflation, or violate the law and stick with price stability. The Fed should not have to face such a choice.
Senator Connie Mack (R-FL) and Congressman Jim Saxton (R-NJ), who co-chair Congress's Joint Economic Committee, have introduced legislation to end the Feds dilemma of choosing between full employment and low inflation. They would do so by repealing the Humphrey-Hawkins Act and replacing it with the Economic Growth and Price Stability Act.
This new legislation would change the Fed's policy mandate by establishing price stability as its primary mission. It would no longer be required to stimulate the economy to create full employment, and could concentrate all its efforts on maintaining the value of the dollar by controlling inflation.
Mack and Saxton believe that in the long run, maintaining price stability is the best thing the Fed can do to keep unemployment down and encourage real growth in the economy, which in turn will create more jobs. Thus, ironically, getting rid of the full employment Humphrey-Hawkins requirement is actually the best way to achieve full employment.
Maintaining the value of our money must be the Fed's first responsibility, and Congress should say so by law.