The Federal Reserve Suffers From A Fatal Conceit And Our Economy Is Paying The Price
Federal Reserve Bank Chair Jerome Powell. (Photo by)
The Federal Reserve suffers from a fatal conceit, and our economy is paying the price.
As expected, at its meeting this week the Federal Reserve did nothing regarding interest rates. President Trump, before and after that decision, blasted Fed head Jerome Powell. Trump critics say he's jeopardizing the central bank's independence. All this, however, obscures a huge question: Does our central bank know what it's doing when it comes to inflation? The answer is, no. The Federal Reserve is doing more harm than good.
The world's most important central bank is afflicted with what the late, great Nobel-winning economist Friedrich Hayek called 'the fatal conceit,' the idea that government planners can run the economy better than the free market. They never have, no matter how brilliant the planners were. Markets are people, and around the world each day they make billions of decisions to buy, sell, invest, start a business, close a business and whatever. People aren't machines. Intrusive governments distort economies.
Hayek's profound insight applies to the Fed. Our central bank isn't running the economy the way communist and socialist central planners do. However, the way it conducts monetary policy is based on the patently false premise that to control inflation it must deliberately try to stimulate or depress economic activity.
Fed officials falsely believe that prosperity causes inflation. On that basis, when prices rise, the central bank attempts to slow the economy or even engineer a recession. When things are sluggish and prices aren't rising so much, it aims to lower the cost of money. The Fed's preferred instrument for this kind economic manipulation is, indeed, interest rates.
What's amazing is how blandly accepted the idea is that the Fed should have the power to try to control the speed at which the economy operates. Parallel to that is the fact that few people blink at the idea that the Fed should set interest rates. This is a form of price control or rent control. Interest is the price one pays to borrow—or rent—money. Borrowers and lenders should set interest rates, not central bank commissars.
Even worse, is that the Federal Reserve confuses the two types of inflation. Non-monetary inflation is changes in the price of things that arise from disruptions to production, such as natural disasters, wars or the pandemic lockdowns. Government regulations and taxes can also raise prices. A 10% sales tax will jack up the cost of an item by 10%.
Jerome Powell mentioned that tariffs, which are similar to sales taxes, may raise inflation. But that's non-monetary inflation, and the Fed can't cure that by putting its foot on the neck of the economy.
What Powell & Co. can do is control monetary inflation. Monetary inflation is a reduction in the value of a currency—in this case, the dollar—usually by creating too much of it. Yet no central banker ever talks about the need for stability in the value of the currency. It's like talking about malaria and never mentioning getting rid of mosquitos.
By falling for the fatal conceit that Hayek warned against, the Federal Reserve is depressing our well-being.
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