The Easiest Way to Cripple Our Economy: Let Politicians Run the Federal Reserve

Several weeks ago, the House Financial Services Committee approved an amendment that would quite negatively impact our economy’s future well-being. If passed, this change could hamper GDP growth for decades to come.

Offered by Congressman Ron Paul, the amendment vastly expands the Congressional Accounting Office’s auditing powers over the Federal Reserve. Consequently, the Federal Reserve’s cherished independence would be drastically curbed. Every unpopular action the Federal Reserve made could potentially be scrutinized by vote-seeking politicians. This would effectively intertwine politics into the serious business of running the economy – and if the Soviet Union taught us anything, that is a terrible, terrible idea.

Imagine, for example, if this policy had been in place three decades ago – during the 70s and 80s. The great economic challenge of those decades was stagflation, a ruinous combination of high inflation, high unemployment, and stagnant economic growth initiated by oil shocks. Presidents from Nixon to Carter attempted to combat the demon, instituting policies that ranged from price controls to handing out WIN (Whip Inflation Now) buttons.

The problem with stagflation, however, was that defeating it required extremely unpopular action. Ending stagflation meant lowering inflation, and combating inflation reduces short-term economic growth, often causing recession (if you find out a way to reduce inflation without doing this, you will revolutionize economics). No sane politician was willing to do this – and so the curse of stagflation remained year after year, crippling the nation’s economy.

In the end, it was Paul Volcker and the Federal Reserve that defeated inflation. To defeat inflation, Mr. Volcker did something no politician would ever do – he started a recession. The Federal Reserve raised interest rates to a high of 21.5%, dramatically lowering the money supply to end inflation. Recession ensued, widespread protests occurred, and Republicans were roundly defeated in the 1982 congressional elections – but Mr. Volcker kept at it.

Eventually the public became convinced that, no matter what the political pressures on it, the Federal Reserve would not give in. Shopkeepers stopped raising their prices in anticipation of inflation. Companies stopped raising wages to match those price increases.

Inflation ended.

Unlike Congress and the President, the Federal Reserve had the will to do the unpopular but right thing. This ability was rooted in the Fed’s independence from the whims of politicians facing re-election.

Imagine, now, if in 1982 the Federal Reserve had lacked such independence. Mr. Volcker raises interest rates; recession ensues. Then Congress, full of politicians facing uncertain re-elections, intervenes. Opportunistic congressmen hold hearing after hearing, demanding the Fed lower interest rates. The House begins investigative audits into the Fed, seeking to pressure the institution. Finally, Mr. Volcker buckles; he reluctantly lowers interest rates, sacrificing long-term economic stability for short-term growth. Inflation continues; the demon of stagflation remains – perhaps even to this day. Imagine the 2009 financial crisis occurring in a scenario of 10% inflation and 8% unemployment. That would be disaster indeed.

The 2009 financial crisis will not be the last. Economic bubbles will exist as long as humans do; humans always believe that “this time is different.” If and when the next bubble pops – the next economic crisis hits – the United States will need an independent Federal Reserve. It will need an institution to do what is politically unpopular but necessary, as was the case last fall. The House’s amendment threatens to destroy this safety net and deprive America’s economy of an invaluable institution. The aggrieved sentiment behind it is understandable, but the Federal Reserve is not Wall Street, and Ben Bernanke was a Princeton professor of economics, not the CEO of Goldman Sachs.

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2 Responses to The Easiest Way to Cripple Our Economy: Let Politicians Run the Federal Reserve

  1. inoljt says:

    First of all, thanks for the critical commentary; I appreciate the differing view.

    As for my response – the Federal Reserve constitutes a government agency, so I’m not against government action per se. There is a difference between independent, competent government agencies (e.g. the CBO, NASA, the Fed) and opinion-poll reading politicians. I’m for the former and against the latter dealing with the economy.

    I am especially against “the political capture of the Fed by both politicians and Wall Street,” as you point out. This amendment will open Pandora’s Box of interference by vote-seeking politicians. Perhaps the Fed’s independence is already diminished – that means we should do all the more to protect what remains.

    Other points: 70s-80s inflation originated from the oil shocks, I did think this through, and my real agenda is to offer insightful arguments – I’m a blogger, not a Wall Street lobbyist.

  2. Afterthought says:

    So why have any government intervention at all?

    Your argument dovetails into an argument to get government out of health insurance, pensions, electricity, etc.

    Furthermore you understate the political capture of the Fed by both politicians and Wall Street by focusing only on Mr. Volcker.

    One might ask, with the Fed on the beat, where did the 70s-80s inflation come from in the first place?

    You obviously didn’t think this through, what is your real agenda?

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