A world with central banking is better than a world without it.
During the nearly 80 years in which the United States functioned without a central bank, financial crises were far more numerous and more severe than the recessions we have experienced since the creation of the Federal Reserve, and that’s including the Great Recession. Plus, there wasn’t even Netflix.
But a world with central banking kinda sucks too, because central bankers seem to know less and less what monetary policy actually does. The Wall Street Journal’s walk-up to this week’s FOMC meeting shows that officials on the interest-rate setting board are clinging desperately to the Phillips Curve (or correlation between interest rates and the unemployment rate). It was once the case that there was a strong, observable relationship: as interest rates rose, so did the unemployment rate.
But that relationship has nearly completely broken down in recent years, and today’s Federal Reserve is raising interest rates on little more than faith that as the unemployment rate continues to fall, labor shortages will ultimately lead inflation to rise. Some even within the Fed think this is nuts. “We are too focused on the unemployment-rate number,” Minneapolis Fed President Neel Kashkari tells the Journal, calling it a “broken measure” that can’t tell us much about how much slack exists in a modern labor market.
In today’s economy, such thinking goes, businesses have more means at their disposal to keep a lid on wage and price increases that we need not fear lower-than-typical interest rates. Raising rates because we assume that the headline unemployment rate is too low will needlessly constrain economic activity and hiring, and rob working Americans of the chance to win the sort of significant wage increases that only happen in times of truly full employment.
The importance of full employment in an economy like the United States’ is difficult to understate. For decades the share of income that is earned by owners of capital rather than workers has been on the rise, likely due in part to the decline of the role of unions in the American economy. Whatever your opinion of the labor movement, you probably will agree that all else equal, American society would be better off with a distribution of income like that which existed in the 1970s than the vastly more unequal society we live in today, and a sustained bout of full employment is the most efficient way of achieving that end.
And there’s a growing body of research arguing that the Great Inflation of the 1970s wasn’t even mostly due to the dereliction of duty at the Fed to manage prices. Instead, some economists argue that the blame can be laid primarily at the feet of oil shocks and widespread crop failures that both sent the economy into a recession and raised prices. If it is indeed true that the price of loose monetary policy in the 1960s and 1970s wasn’t all that high, then the Fed is needlessly inflicting economic pain on millions of Americans who can least afford to shoulder that burden.
But the Fed is not abandoning the Phillips Curve for this interpretation of the Great Inflation. A committee like the Federal Reserve must take into account the often contradictory viewpoints of its many members, and from the public comments of once dovish board members like Eric Rosengren, many members are scared that inflation is about reemerge and force the Fed to sink the economy into a recession in order to eliminate it.
The Federal Reserve is caught between two mutually exclusive interpretations of the world. Either the central bank is primarily responsible for bouts of inflation, or it isn’t. If inflation is indeed primarily a result of bad monetary policy, it’s difficult to see how the United States will avoid a destabilizing inflationary period, given the extraordinary amount of monetary stimulus in the system and the growing fiscal deficits in our future. If inflation is mostly caused by shocks to the economy outside the central bank's control, then the Fed should be blamed for the dismal state of the American worker, as it has failed to achieve full employment for almost all of the past forty years.
Central banks are the blind who lead the blind, and it should strike fear in the hearts of Americans to realize how little these experts know about the full effects of the powerful tools they wield everyday. It’s enough to get you to donate to a Ron Paul or Bernie Sanders presidential campaign. Well, almost enough.
Christopher Matthews is a writer who splits his time between New York City and Accra, Ghana, with an interest in the intersection of markets, the economy, and public policy. He previously held staff positions at Axios, Fortune Magazine, and Time Magazine, and has been published in Forbes and Debtwire.