Whose Monetary Policy Is It Anyway?

Whose monetary policy is it anyway? I am talking about monetary policy in the United States. Our central bank, the Federal Reserve Bank, runs monetary policy for the country, but their job is complicated by the fact that the President and Congress run fiscal policy. And, one more thing, they also come up with all the free trade policies, energy policies, foreign policies, and all the other policies that can and do affect the running of monetary policy by the Fed. No one in their right mind, in my opinion, would want the job of being the head of the Fed. All that responsibility and not really having any control over all those other policies that make running monetary policy just about impossible.

On Wednesday, the Fed decided to easy up a little and only reduced the key interest rate, known as the Feds Funds rate, a quarter of one percent. Some economists interpret this move as the Fed is at the end of easing interest rates for this cycle. That very well might be the case. The economists go on to say that the Fed is concerned now with inflation. Inflation, we all know is in part responsible for the increases in oil, gasoline, diesel and food prices here in the United States. Then the economists explain how by continuing to lower interest rates, investors will sell dollars and invest in other currencies where they can get higher interest rates. And, these economists go on to say that as a result of the quarter point reduction in the Fed Funds rate that the dollar is going to strengthen and prices of oil and food will start to come down.

That all seems to make good sense, but I do not see it that way. First, the demand for oil around the world will continue to grow regardless what we do here in the United States. Unless we are planning on reducing our oil consumption by some big number, I do not see much room for change. We are not the only player out there buying oil. Second, and the economists know this, but for some reason did not go into this, we, as a nation, will continue to borrow large amounts of money by issuing US Treasury debt. This borrowing puts pressure on the dollar too.

So, now we have Fed Funds at 2%, and the prime rate that is set by banks, and based off of the Fed Funds rate will now be at 5%. But, there is no law saying that if the Federal Reserve Bank lowers the Fed Funds rate, commercial banks have to lend money. Banks have tightened their requirements to lenders after first going too far the other way. Banks make mistakes too, although some get it right most of the time. With the price of gas at an average of $3.62 per gallon, you do not have to be a banker to figure out that the average family is going to have less disposable income after paying for a fill up at the pump. Credit card debt, something a number of people do not use too wisely, has been affected as debtors struggle to maintain their life style. All of this will tend to make banks more cautious in their lending practices.

But, let us get back to monetary policy and the question, whose policy is it anyway? As you can see, running monetary policy is much like being a plumber in a flood. You have all your tools and you know what to do, but there are forces over which you have no control that is making your job nearly impossible to do.

In a perfect monetary policy, one that exists only in my mind, the growth of the money supply and the setting of interest rates would all be tied together. In other words, as head of the Federal Reserve Bank, I would have the power of the Pope when it came to the dollar. (After all, it says “In God We Trust” on our money.) The Founding Fathers did not envision that money would take the many forms it has in 1789. Had they been able to look into the future, some of them would have, in my opinion, have created then and there, a fourth branch of government - the Federal Reserve Bank. You see, our Federal Reserve Bank is a creation of Congress. That is why Ben Bernanke goes before Congress and answers their monetary policy 101 questions every so often. Had the Founding Fathers created the central bank as the fourth branch of government, the head of the Fed would have the power to maintain the integrity of the dollar. Presidents and Congress would know going in what the Fed could and would do to preserve the value of the dollar for ALL THE PEOPLE.

Monetary policy today is segued in favor of commerce, developers of real estate and other big borrowers. This does not wash in my book of monetary policy, and because of this, you will not see me running the Fed. Yes, commerce is important. The growth of the economy is important, but not at the expense of the integrity of the dollar and those little people out there that keep their savings in a bank. And, let me take one more step. If the dollar did not suffer from an almost continuous loss of purchasing power, read that as inflation, just perhaps, investors would not have to reach for the most risky of investments. I am not saying this would be a cure for greed, but if people could SAVE money and know that their purchasing power was being protected, would they still feel the need to take such big risks (to compensate for their loss of purchasing power)? I have no evidence that a stable dollar would mean less risk taking when people invest, but I can not believe that an unstable dollar does not promote more risk taking. I offer this as something to think about. Stay tuned.