Monetary policy seeks to promote economic growth through the proper management of the currency. The trick is to create enough money to provide growth without losing control of inflation. This is no small task. We are a nation addicted to growth, and we are not a patient people. In the past it was complicated by foreign trade and the relative value of currencies. As long as all currencies were tethered to a fixed value such as gold it was easier, but even that did not eliminate complicated problems in foreign exchange.
Monetary policy used the tools of money and credit creation such as buying and selling treasury securities and raising and lowering interest rates. As complicated as the single task of monetary stability and controlled growth is, it is complicated enormously by the additional mission of providing full employment.
It is the addition of full employment to the mission of the Fed that crosses the line from monetary policy to fiscal policy. The Congress controls fiscal policy through taxation and regulation. The challenge is to provide the revenue needed without taxing so much that the incentive to produce the revenue is inhibited.
Presidents have long realized that higher tax rates did not necessarily produce higher tax revenues. Calvin Coolidge noted this long before the well known Laffer curve was drawn on a napkin for Donald Rumsfeld and Dick Cheney by its namesake Arthur Laffer, who was simply, yet brilliantly, explaining the work of Robert Mundell (later awarded the Noble prize in economics.)
Part of the reason we have reached the economic pain we are at is because of the success of the Federal Reserve to mitigate the accumulation of bad fiscal policies with offsetting monetary policy. Alan Greenspan was considered the Maestro because he seemed so adept at using the tools of the Fed to counter problems created in the Congress that the lawmakers were insulated from the results of their own foolishness.
As long as the Fed was able to stimulate the economy with lose money and credit then Congress did not have to face the outcome of higher minimum wages ( higher unemployment, especially among the lowest income brackets), higher taxes and stifling regulations.
We have now reached a point where the accumulation of bad fiscal policies has exceeded the ability of the Fed to mitigate. Decades of bad policies have accelerated with the addition of terrible bills and policies passed during the first two years of the current administration. We have been unable to recover from the last bailout before the next bailout is required. Too many problems accumulate in too short a time frame and the classic responses of inflation and deficit spending no longer work. Debt is never a problem during the boom, but it is lethal during a bust.
What once worked no longer does. Success- knowing what worked yesterday- has led to failure.
Then the outcome of higher minimum wages rears its ugly head and the unemployment is no longer hidden by Fed policy. The effects of onerous regulations and higher taxes brings production to a stop. Hallow financial instruments collapse. Money poured into housing no longer supports ever increasing prices.
When we realize that monetary policy can no longer hide fiscal mismanagement we are faced with making adult decisions. Over generous benefits must be rescinded. Government expenses must be cut. Common sense must return to fiscal management.
Laffer’s mentor, Robert Mundell, warned of the use of the Fed to enact fiscal policy. It is healthy to realize the limits of the power of the Fed, but this entails that the Government must realize the consequences of its policies without the Fed hiding the results with loose money as it has for decades.