The Case for Decentralizing Monetary Policy

Money for much of history has been something closely regulated by the state and today that trend has been steadily increasing. Whether it’s commodity standards like gold or today’s fiat currency, which the government can issue at will, the state has always had a close eye on the money supply. This is rather curious because we should know by now that the market tends to manage things far better than the state. Just look at grocery stores in the United States and grocery stores in a communist country like North Korea or Cuba. Of course, this isn’t an argument to privatize everything and anything but it should be reasonably understood that decentralized decision-making tends to work for most things and money should fall into that category. 

That’s the case that John Wood’s short book Monetary Policy in Democracies: Four Resumptions and the Great Depression makes when he gives an in-depth account of the history of central banking in the United States and England. He explains that such banking regimes were kept under strict central scrutiny and control regardless of whether it was the Bank of England, the Bank of the United States, or the US Federal Reserve. All of these entities varied in the level of power they possessed but the strong central involvement in the business of money was clear. Wood argues through his detailed accounts of the shortcomings and complications of attempting to centrally manage the money supply that such matters should be democratized as much as possible. That could be achieved by giving more power and authority to regional banks or completely getting the government out of the business of banking entirely. Either way, it is clear that the highly centralized public management of money has insulated key decision-makers from the intricacies of everyday monetary affairs. The core problems associated with this suboptimal dynamic could be remedied to some degree with the decentralization of monetary policy.

The Political Shortcomings of Central Banking

One of the core benefits of the market as opposed to the political system is that there is no arbitrary decision-making and all decisions are made in the interests of the beneficiaries, i.e. the people. In the marketplace decisions on how much of something to produce and at what rate are determined by the willingness of consumers to buy and the willingness of suppliers to sell. It’s a win-win situation and allows for countless preferences to be weighed and processed with a great deal of rapidity. The same cannot be said about the public sector. Wood recounts on the plethora of political considerations and deliberation that went into running central banks such as the ones in the United States and the United Kingdom. 

Wood writes,

“The Fed must always take into account the political implications of its decisions. It is a creature of Congress, and a significant divergence of monetary policy from the will of the electorate might end in the elimination of the Fed. But monetary policy has been conditioned less by short-term political factors than by the absence of the gold standard.”

There is much to unpack in this statement such as the aforementioned political considerations that go into decision-making at the Fed which is supposed to be an apolitical body. In what position are elected officials able to ascertain what the best monetary manoeuvres are just based on democracy? It doesn’t matter what the voters want; bad policy results in bad outcomes. Furthermore, Wood rightly notes that one of the most important monetary events has been the removal of the gold standard which pegged currency to something resembling a market mechanism. 

As bad as politicized monetary policy is, overly independent policy could also be a bad thing too. Wood notes,

“Missouri Congressman L.C. Dyer ridiculed the depiction of the Board as the “supreme court of finance” by quoting a report of the St. Louis Clearing House Association to the effect that whereas justices had been trained for a profession that was compatible with judgeships, the Board could not include any stockholder or officer of a bank.”

In this case, there is a question of who should be in control of financial policy if that person is not to be accountable to the public. Of course there is a sweet spot between independence and democratic accountability but that is certainly a small target. Oftentimes central banks and subsequently our currency become a tool for the government to use to forward its goals, not the goals of the public. Wood notes that the Bank of England was often called on to raise money for wars and the US central banks from the Bank of the United States to the Federal Reserve have all been called on to support the functions of the state. This raises many issues such as the inability of the bank to conduct itself outside the realm of partisan politics. Oftentimes banks are called upon to sacrifice long-term monetary stability with short-term spending goals. Modern Monetary Theory is a clear example of an economic philosophy which sees monetary policy as purely an arm of politics and not an essential market function. Although MMT is not mainstream, it can be observed in moderate practice across history as banks enact policy based on the demands of the government rather than what is optimal for the market. 

Whether or not decisions are made with politics or independence in mind, it’s the arbitrary will of those in power that makes money something worth taking out of the hands of government as much as possible.

If money is not to be completely privatised, Wood argues that a more moderate solution would be to understand that 

“Money, like other goods ought to be produced and managed for the benefit of those affected by the people and organizations that suffer penalties for unsatisfactory performance. Anything else is short of democracy in any meaningful sense. Failing that, as a definitely second-best solution if government continues in control, its agency should be closely attuned to the public as possible. This means more, not less, influence of the regional Federal Reserve Bank president on the Federal Open Market Committee.”

Of course, when Wood says democratize he doesn’t mean a populist tug of war led by politicians but the same type of democracy a grocery store exercises. Where every single person gets a voice with their individual and voluntary actions to buy or not to buy. Or a better example, a private banking system, which is perpetual back and forth between consumers and suppliers. Bringing the business of banking and money creation to the most intimate level possible by decentralizing decision-making would at least bring the current system closer to a market-based one. Decisions regarding something as important as our money should not be made from a thousand miles away in Washington, DC, next door to all the power-hungry politicians. 

Key Takeaways

I think it’s fair to say that the world is reaching a new frontier of monetary policy. Fiat currency around the world is being pushed to its theoretical limits as trillions of dollars are being printed to finance stimulus packages. Interest rates in the United States are near zero and Europe has crossed into the experimental realm of negative interest rates. Meanwhile there is talk of the implementation of digital currencies and cryptocurrency is gaining mainstream popularity, albeit they are still not legal tender. It is an exciting and frightening time for the very notion of currency. Wood’s book was published in the year 2000 and cites history dating back hundreds of years, yet today those lessons are as timely as ever. Policy makers should heed the lessons of history and the principles of sound money to ensure that the future of money is guided by the democratic tendencies of the market rather than the arbitrary hand of the state.

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