When I first started getting into Econ sometime last year, I thought those calling for the abolishment of the Fed where a little bit loony. As with any notion that is originally found extreme I thought it implausible and dangerous. I've come around. Having a central bank that is able to manipulate the interest rates of a whole economy is in fact the implausible and dangerous action. That being said, I don't foresee the termination of the Fed as anything that will happen in the near future. Now that you know where I stand on the issue, let's look at
Greg Mankiw's upcoming
letter in the New York Times:
Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.
Normally I would talk about the lunacy of this proposal as if fits in my ideal society, but we don't live in my ideal society. My society wouldn't have a central bank. Given the fact that we do have a central bank, and looking at the proposed policies, arguing for an explicit negative rate from the Fed almost seems like the least of all evils. (I'd still argue that the best action would be to give the people a set of guidelines that won't be changed and tell people to deal with it, instead of changing policies willy-nilly and promoting confusion). I have seen and read commentary arguing that the Fed funds rate is effectually already negative, but for the Fed to be explicit in their pursuit of rampant inflation (by acting with the Treasury) as a means to produce negative interest rates would be troubling. The power to even theoretically pursue such a policy is troubling. Imagine being a responsible long-term lender and you have entered into contracts over the last few years with a nominal interest rate of 5%. Each lender has a responsibility then to also adjust that nominal rate so that it reflects the effects of inflation. Without a central bank, lenders are directly responsible for their own analysis of the perceived underlying inflation or deflation in the economy. But with the Fed present, lenders need to somehow factor in the potential manipulation of a currency by central bankers that are nominated by the Administration. While many efforts have been made to minimize conflicts of interest between Fed members and the Administrations nominating them, and while I'll assume that Fed members act in the best interests of society, there is bound to be some influence put upon a Fed so focused in DC. To ask lenders to take losses on responsible loans is another bailout for those who overextended themselves during the last decade.
Now, it could be argued that a bailout to the borrowers will at least allow them to pay back some of their debt instead of simply defaulting on it and going into bankruptcy. But for Mankiw to still be talking about 'aggregates' as if that all-encompassing-word could ever possibly hope to reflect the underlying complexities of society, is in my opinion misguided. He may think that this proposal is the best one on the table, or he may be proposing what he thinks has the best chance of actually passing through Congress/the Obamadministration. Nonetheless, the more the government stays out of the way and the sooner it let's entrepreneurs step in and assess the situation the better off we will all be. Instead, the government seems set on trumpeting its own importance and trying to clean up the mess that its myriad of follies helped create. I'm by no means trying to oversimplify the situation and simply blame everything on the big, bad government. Private actors were an integral part of this collapse, but the government has done its best to make sure these private actors don't pay the price for their mistakes.
I've gotten a little off topic, but the points remains the same. Promoting more government intervention may be the proposal to actually get serious consideration, but it promotes using the very institutions that manipulate reality in hope of keeping the curtain pulled over the imbecile wizard.
