Is the Fed a Failure?

From Barron’s:


Has the Federal Reserve Bank served its purpose? An economics professor suggests it hasn’t, and that its 100th birthday, next year, should be its last.

Our church of the monetary mandarins turns 100 late next year, a centennial that not everyone will regard as cause for celebration. I refer, of course, to the Federal Reserve System, created by an act of Congress and signed into law by President Woodrow Wilson on Dec. 23, 1913.

Most economists might be open to reforms of some of the Fed’s practices. Indeed, a major reformer is the central bank’s own current high priest, Ben S. Bernanke. But the mainstream still has no doubt about the Fed’s positive impact on the economy, an unquestioning faith that could be partly motivated by self-interest. The Fed is not the only institution that offers our dismal scientists money, power and prestige, but it has certainly done a great job in that regard.

Only a handful of heretics have dared to ask about the job the Fed has done on the economy. One is George Selgin, an economics professor at the University of Georgia whose method of indictment is refreshingly straightforward.

It would be one thing to argue, based on some non-mainstream theory of the dynamics of money and credit, that a central bank is a bad idea. But Selgin forgoes such subtle arguments, preferring instead a simple before-and-after approach. He asks whether the economy, as measured by the central bank’s own objectives, performed better after the Fed was created than it had before.

He biases the record in favor of the central bank by mainly taking as his “after” period the years since World War II, thereby forgiving the Fed the Great Depression of the 1930s. His “before” period starts in 1870s. In a long and lucid talk, replete with displays (available on YouTube as “A Century of Failure”), he declares: “The pre-Fed system stank.” But was it any worse than the system instituted by the Fed?

Data exhaustively reviewed by Selgin include the unemployment rate, the price level, the volatility of economic fluctuations and the incidence of recession. On that last measure, his findings may come as a surprise to those familiar with the standard data. None other than Christina Romer, President Obama’s former chairwoman of the council of economic advisors, did revisionist work on the standard recession data and found the pre-1913 recessions to be much less serious than previously believed.

Economist Selgin’s bottom-line finding: In virtually every conceivable respect, the economy performed at least as well pre-1913 than post-World War II, and usually better.

In a world with fewer true believers in the Fed’s divine right to rule, the burden would be on the central bank to prove that the period of its reign has been a better one for the economy than the period before it took over.

There is also a good reason for believing that the Fed has done more harm than good: the much larger role of government and its counter-cyclical stabilizers post-World War II as compared with pre-1913. Due to that factor alone, mainstream economics itself dictates that the economy should have performed better in the more recent period. If instead it performed worse, what might be the cause? A chief destabilizing suspect: the Federal Reserve itself.

Selgin has written a paper on this topic, with two other economists, that will soon be published in the Journal of Macroeconomics. It will provoke us all to ask the heretical question: Should the central bank’s 100th birthday be its last?


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