NCPA - National Center for Policy Analysis


July 10, 2009

Why is it that those who specialize in individual athletic events hold almost all the records as contrasted with those who compete in the same events as part of a pentathlon?  Like the athlete who tries to do everything (or at least five things), the Federal Reserve (the U.S. central bank) is becoming less competent as the number of its functions increases, says Richard W. Rahn, a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

For example:

  • The Fed is supposed to provide the United States with stable currency yet it now takes $21.60 to equal the purchasing power of $1 in 1913, the year the Fed was established.
  • The Fed is supposed to regulate the banking system to provide financial stability, yet far more banks have failed since the Fed was created, and events of the past year illustrate how the Fed has failed at providing financial stability.

The Fed suffers from conflicting responsibilities both within the organization and with other government agencies and actions, says Rahn:

  • It is charged with maintaining full employment, but the long-run level of employment depends far more on government fiscal policy (tax rates, government spending and regulatory burdens) than on monetary policy.
  • During the great inflation of the late 1970s, the money supply as measured by M1 (currency and checking accounts) grew by almost a record 40 percent in four years, and yet in the past year alone M1, has grown by almost 20 percent.

The reason inflation is stable despite the rapid monetary growth is that velocity -- the number of times a dollar is spent in a year -- has been falling.  People have been hoarding cash rather than buying new homes or autos, explains Rahn.

Once excess inventories are worked off and global commodity prices begin to rise again, inflation fears will come back quickly and people will rush to get rid of their dollars by buying "stuff."  Unless the Fed can quickly extinguish all of the new money it has created, inflation will come roaring back, says Rahn.

The Fed needs to be split up, the Fed's bank regulatory functions need to be put into a separate agency and the new central bank should not be required to buy government debt.

The smarter folks in Washington understand that the trillions of dollars of new spending will be "paid for" largely by the "inflation tax," which will fall hardest on those without assets -- i.e. the poor.

Source: Richard W. Rahn, "The Expanding Fed Role," Cato Institute, July 8, 2009.

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