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Central Bank Mythology

Gerald O’Driscoll, Jr. writes Debunking the Myths About Central Banks in he Wall Street Journal 2/38/13.

Excerpts:

The Bank of Canada was not founded until 1935. The Canadian banking system survived the Great Depression with no major bank failures. By contrast, thousands of U.S banks failed, despite the existence of the Federal Reserve. These large-scale failures were ended by FDR’s bank holiday, not by any Fed contribution to banking stability.

In the 1950s, under Fed Chairman William McChesney Martin, inflation remained low. Yet his had little to do with Martin. President Eisenhower was an inflation hawk, and throughout the 1950s budget deficits were low or nonexistent. Once Presidents Kennedy and Johnson accepted Keynesian fiscal activism, deficits rose. Martin was happy to accommodate the government with easy money. He did not believe monetary policy could—or should—operate independently of fiscal policy. What followed was the first peacetime inflation in U.S. history.

The lesson from this history is what I call “central banking without romance,” after a famous article by the late Nobel prizewinning economist James M. Buchanan, “Politics Without Romance.” A central bank is necessary as long as an economy is wedded to a fiat currency. And it may at times behave independently—but not in the face of large-scale budget deficits, as we have today.

HKO

The article should be read completely.  It is hard for me to conceive of a truly independent Fed, for that would require constraints that are politically unpopular.  Fed critics and conspiracy theories contend that the Fed serves the private and public power structures, and facilitates irresponsible fiscal behavior.  But the Fed may also be limited in how it can overcome poor fiscal policies. The Fed may have served the political structure worst in its willingness to hide their fiscal shortcomings.

 

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