Let the Fed put money where it’s really needed


The US Federal Reserve is surely the most powerful and misunderstood institution in the world. It was designed just over 100 years ago for a distinct task: to ensure that the country has enough money to keep the economy growing at its full potential.

But during this period it has come to support the global market system and in recent years it has created a bubble in everything that is slowly but surely beginning to burst. As a result, the Fed is trying to walk an impossible line between the inflation management it helped spark and the recession that could follow as it attempts to stabilize prices.

How did we get to this strange and untenable place? Some would blame it on the massive quantitative easing program launched in response to the 2008 financial crisis, followed by support for a number of asset classes after the pandemic.

Others would say the problems started after the 1970s, when the end of the Bretton Woods system gave central bankers more freedom to extend economic cycles. American politicians of both parties have abused this freedom, avoiding tough “guns or butter” policy choices and returning responsibility for economic policy-making to the Fed.

Lev Menand, a former senior adviser to the Undersecretary of the Treasury in 2015-2016 and an associate professor at Columbia Law School, would go back even further, to the 1950s. At that time, the chairman of the Fed was William McChesney Martin.

It broke with the New Deal banking system of the 1930s and allowed the New York Fed to begin lending to a select group of non-bank brokers, creating the “repo” market. As Menand points out in his new book, The untied Fed: the central bank in times of crisisit was the start of a dangerous cycle of mission drift.

Even then, Congress complained that the Fed’s actions were illegal. Martin simply responded by asking them to change the law. They never did, but the shadow banking system — in the form of everything from repos and Eurodollars to commercial paper and money market funds — grew, and the Fed continued to support all of these entities. ghosts. In turn, they grew larger and new types of shadow banking were created, contributing to a “financialization” of the economy that has been linked to slower growth, greater inequality and greater financial volatility.

Today’s Fed is struggling to get ahead of inflation. But as Menand points out, fighting inflation wasn’t even part of the central bank’s official mandate until 1977. While former Fed Chairman Paul Volcker had to remove the “punch bowl (a term first coined by Martin) in 1981 with increases in interest rates, his strength in some ways allowed for greater congressional weakness.

“There was a feeling among inflation-weary politicians that ‘if he can fix it, let him,'” Menand says. Since then, Congress and the executive branch have increasingly moved away from adopting a whole-of-government approach to financial stability, preferring to let the Fed take over economic policymaking. And yet, all the central bank can do is support asset prices. It cannot create new business ideas, or retrain workers, or roll out a Green New Deal, or redesign commerce.

Hoping that the Fed — an unelected technocratic body with a limited toolkit — will magically fix what’s broken in our economy is like “expecting the Supreme Court to fix our social and political problems,” Menand writes. Court actions lately have just the opposite effect. And it’s likely that the Fed’s current battle with inflation won’t end well either. A hard landing and the accusations that will surely follow could further trigger the extreme politics we saw on both sides of the Atlantic after the Great Financial Crisis.

So where do we go from here? Perhaps another round of Fed reform, although that is unlikely to happen before a major crisis. The original Federal Reserve Act of 1913 was the result of two decades filled with financial crises. Indeed, half of the years between 1890 and 1913 were spent in recession.

We may be heading for a slowdown now. When the markets emerge from the chaos that will ensue over the next few years, we will have to find a way for the Fed to better fulfill its original mission of managing the money supply and supporting the banking system, without underwriting ever more bubbles in a massive and speculative market. financial sector that primarily serves itself.

It is unlikely that politicians will stop shifting responsibility for policy-making to each other, or that shadow banks will be thwarted by formal charters, anytime soon. Perhaps the simplest and most elegant short-term solution would be to allow the Fed to focus less on financial institutions and more on real people.

One idea is for individuals to hold Fed accounts. Such digital wallets could provide central banks with a way to get money more precisely and directly to where it’s needed during a crisis. “Money could be distributed to people, not to banks, under specific terms and conditions, at specific times,” Menand suggests.

It is not a solution to the larger problems of our political economy. But it could help the central bank better fulfill its main mission: to put money where it is really needed.

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