The Fed’s On the Job

The problem is, no one’s quite sure what the job is. Congress famously chartered the Fed to control inflation and use monetary policy to maintain “full employment”. These contradictory goals have given the Fed fits for decades. But the Fed has other responsibilities, including preserving the integrity of the U.S. banking system. So while most economists seem to think that controlling inflation is more important than avoiding recessions, I’ve not read much about the third goal. Now I am. Some economists are thinking that the preserving the credit system trumps both the inflation and recession problems. I’m not so sure, but their arguments seem to have merit. I confess: this is above my pay grade! What I do know is that the collapse of banks in the 30’s was a big contributor to the Depression. But then, government had mandated that banks could not spread their risks by operating in multiple states. Today’s problem is different: government mandated that banks issue very risky mortgages. In both cases, it took decades for the consequences to materialize. The long term lesson concerns the folly of trying to overrule the iron laws of economics through legislation and regulation. But in the short term? Well, we’ll either get past the credit crunch or we won’t. If the Fed succeeds, banks won’t fail but we will experience severe inflation. And if the Fed doesn’t succeed? Look for breadlines.

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