Last week in the Wall Street Journal, Paul Kupiec argued that the Fed’s new emphasis on “macroprudential” management is basically central planning and is likely to decrease financial stability and slow economic growth.
A similar argument was made a few years back by Jeffrey Hummel (here) and debated by David Glasner (here) and Kurt Schuler (here), and Bill Woolsey (here) with a summary at the Sound Money Blog (here).
To many free-market economists, the claim that the Fed is not a central planner seems rather bizarre. The Fed is central. The Fed is a planner. The Fed is a central planner. Although I can’t claim to fully understand the reasoning behind the proposition that the Fed is not a central planner, I can think of three possible explanations.
1. The Fed is not central.
When the Fed adds money to the economy, the funds are allocated by the decentralized financial markets to their most highly valued uses. This is true, but the Fed’s monetary decisions are clearly centralized since they are undertake through open-market operations by the Federal Reserve Bank of New York and set by the Board of Governors in Washington, DC. The Fed is, after all, a central bank.
2. The Fed is not a planner.
In the large and distributed U.S. economy, the Fed cannot possibly know what the ultimate effects of its monetary injections will be. But clearly the Fed is trying to influence those decisions. Lowering interest rates has the predictable consequences of increasing consumer spending and business investment. Fed actions are intended to influence the economy according to some plan.
3. Central planning is neither central nor planning.
As odd as it may sound, I think is the argument most people have in mind when they claim the Fed is not a central planner. Central planning, they assume, is the realm of pure socialism. It’s government ownership of the means of production. It’s the command-and-control economy of the Soviet Union. No one still believes such a system can be economically efficient.
And yet, then Fed’s polices are of the same manner, just of a lesser degree. In the early 2000’s, the Fed encouraged the widespread ownership mortgages and mortgage-backed securities. Macroprudential regulations attempt to control which assets banks are allowed to buy and how much of each. The bailouts of the recent financial crisis targeted to support specific banks and types of bank assets. As Hummel describes “the Fed now tries to determine to which sectors the economy’s savings flow.” These are the actions of a central planner that, like a Soviet commissar, is bound to lead to misallocation of resources and inefficiency in the economy.
One other point made by Timothy Lee is that easy money by the Fed does not necessarily constitute central planning. Since we have a Fed, it must do something with the money supply, and sometimes an easy-money policy is needed.
But the Fed has gone far beyond what was needed. Its marcoprudential regulations, bank bailouts, and credit allocation policies attempt to steer the economy, not just support it. In its attempts to mold the economy in whatever ways it sees fit, the Fed has become an agency of central planning.