By: Peter Klein
November 5, 2013
President Obama has nominated Janet Yellen to chair the Federal Reserve.
The first woman up for the position, Yellen was nominated only after a sustained media frenzy. Both Yellen and her top competitor, Larry Summers, were routinely subjected to amateur psychoanalysis by professional political pundits.
Summers was eventually forced to withdraw from consideration after analysts dissected his “famously difficult personality,” condemning him as “a jerk” with a “proclivity toward arrogance and disdain of others.”
That so much importance is placed on the Fed chief’s temperament may seem absurd. But this indicates a much deeper problem: the Fed has too much power.
The Federal Reserve is the most important economic planning agency in the world. It’s charged with promoting full employment, stabilizing prices, and overseeing the financial sector. So the new chair’s theoretical views, management style, and personality quirks could affect trillions of dollars of economic activity.
Is it wise to hand such extraordinary power to an elite cadre of economists and bureaucrats?
The pretenses of top-down planning have been debunked by history. Throughout the last century, every nation that adopted central planning had its economy flounder.
Even at the microeconomic level, the limits of top-down planning are increasingly obvious.
Organizations, public and private, are becoming more decentralized. Large corporations are scaling back hierarchies to encourage bottom-up innovation. Wikipedia has displaced Encyclopedia Britannica. The creative collaboration behind open-source software drives technological evolution and user savings.
Why should monetary policy be any different? Why do we need a government agency, operating largely in secret and without effective oversight, managing the money supply, setting interest rates, and telling banks what to do?
The prices of most goods bought and sold in the U.S. are governed by the choices of buyers and sellers on the open market. With commodity money, such as a gold standard, the quantity and value of money, along with the interest rates that coordinate borrowing and saving, are determined in the same way.
When a government agency controls the money supply and manipulates interest rates — as is done today — the decisions of entrepreneurs, investors, workers and consumers are shaped by the beliefs and values of a handful of government planners.
Given the Fed’s remarkably poor track record, switching to a market-based money supply would be a big improvement.
By rapidly increasing the money supply and slashing the federal funds rate, the Fed encouraged the sustained malinvestment in capital that eventually caused the 2008 financial crash.