In the made-for-TV movies Tom Selleck plays Jesse Stone, and in one of them he is told that the town council wants to see him. One of his crime investigations has annoyed them for some reason and, in some exasperation with the police chief’s unapologetic manner, a member decides to remind him that “we could fire you.” To which Stone, still seated, replies, “You can. But you can’t tell me what to do.”
No one said those lines at the recent hearings before the House Financial Services Committee that had brought Federal Reserve Chairman Janet Yellen to Capitol Hill to testify. But the meeting resulted in a very similar standoff.
Congress, of course, cannot fire Yellen, who, while unapologetic, was certainly cooperative and forthcoming. Some members of the committee want the Fed to do something that she believes would be disastrous for monetary policy and for the U.S. economy.
At the heart of the disagreement is a pretty fundamental idea that human decision-making in monetary policy can and should be replaced by a fairly simple algorithm distilled from key economic variables. And Yellen recognized immediately that this would anesthetize the Fed and eventually allow Congress to take control of monetary policy.
The idea behind it comes originally from the late Milton Friedman, whose analysis of our monetary policy found that Federal Reserve decisions were chronically and systemically late and, as a result, often did more harm than good. He believed that because the information supporting the decisions took too long to develop actionable patterns, the Fed should abandon the idea of regulating the economy through market interventions and simply expand the money supply steadily to accommodate the needs of the growing economy.
It was an appealing idea, especially to those who believed in the value of less economic meddling. Over time, Friedman’s idea has been modified to include substituting an economic model for human decision-making at the Fed. This is the essence of the “Taylor Rule,” developed by Stanford University economist John Taylor. It is a straightforward set of economic variables — inflation, employment and interest rates — arranged to indicate when the money supply should be expanded or contracted. In its simplest form, it is Friedman’s idea with umbrellas or sunglasses to suit the always changing economic weather conditions.
There is a very strong resemblance between the Taylor Rule and the system the Federal Reserve actually uses these days; so much so that we might wonder what the operatic drama was all about during the Congressional hearings.
In a sense, the roots of the argument go deep; all the way back to our very first president, George Washington, our very first Treasury Secretary, Alexander Hamilton, and our very first Congress. The initial argument then was over the debts accumulated by the Continental Congress in the fight for independence and whether our new country should pay them, walk away from them, or do something in between. Soon, this initial argument was expanded, and included the question of whether we needed a national bank.
The first argument was eventually resolved; the second turned out to have everlasting life. Today there are quite a number of people who believe that our economy and our country would be better off if we didn’t have a central bank.
There is no doubt that the Federal Reserve can sometimes seem unresponsive to the needs of ordinary citizens and smaller businesses and far too attentive to the interests of big banks and Wall Street. And there is little question that the Fed has an abiding faith in the curative value of liquidity for financial markets and has over-prescribed it to a clearly addicted patient.
All of this, from Alexander Hamilton to Jesse Stone, public distrust of big banks to Congressional jealousy of the Fed’s independent ways, explains why the subtext, or libretto, for the operatic hearings last week dwarfed the actual agenda.
As this drama plays out we should probably remember a few things. One is that it is very easy to magnify the Fed’s shortcomings, faults and failures to the point where we forget what a good job overall it has done for us and for our economy. We should bear that in mind, especially when we consider what our economy would look like if the Congress took over monetary policy and applied the same wisdom, responsibility and financial skills it has used to manage the federal budget.
In short, be careful what we wish for.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for The Herald Business Journal.