Skip to main content
Menu

Main navigation

  • About
    • Annual Reports
    • Leadership
    • Jobs
    • Student Programs
    • Media Information
    • Store
    • Contact
    LOADING...
  • Experts
    • Policy Scholars
    • Adjunct Scholars
    • Fellows
  • Events
    • Upcoming
    • Past
    • Event FAQs
    • Sphere Summit
    LOADING...
  • Publications
    • Studies
    • Commentary
    • Books
    • Reviews and Journals
    • Public Filings
    LOADING...
  • Blog
  • Donate
    • Sponsorship Benefits
    • Ways to Give
    • Planned Giving

Issues

  • Constitution and Law
    • Constitutional Law
    • Criminal Justice
    • Free Speech and Civil Liberties
  • Economics
    • Banking and Finance
    • Monetary Policy
    • Regulation
    • Tax and Budget Policy
  • Politics and Society
    • Education
    • Government and Politics
    • Health Care
    • Poverty and Social Welfare
    • Technology and Privacy
  • International
    • Defense and Foreign Policy
    • Global Freedom
    • Immigration
    • Trade Policy
Live Now

Cato at Liberty


  • Blog Home
  • RSS

Email Signup

Sign up to have blog posts delivered straight to your inbox!

Topics
  • Banking and Finance
  • Constitutional Law
  • Criminal Justice
  • Defense and Foreign Policy
  • Education
  • Free Speech and Civil Liberties
  • Global Freedom
  • Government and Politics
  • Health Care
  • Immigration
  • Monetary Policy
  • Poverty and Social Welfare
  • Regulation
  • Tax and Budget Policy
  • Technology and Privacy
  • Trade Policy
Archives
  • April 2021
  • March 2021
  • February 2021
  • January 2021
  • December 2020
  • November 2020
  • October 2020
  • September 2020
  • August 2020
  • July 2020
  • June 2020
  • May 2020
  • April 2020
  • March 2020
  • February 2020
  • January 2020
  • December 2019
  • November 2019
  • October 2019
  • September 2019
  • August 2019
  • July 2019
  • June 2019
  • May 2019
  • April 2019
  • March 2019
  • February 2019
  • January 2019
  • December 2018
  • November 2018
  • October 2018
  • September 2018
  • August 2018
  • July 2018
  • June 2018
  • May 2018
  • April 2018
  • March 2018
  • February 2018
  • January 2018
  • December 2017
  • November 2017
  • October 2017
  • September 2017
  • August 2017
  • July 2017
  • June 2017
  • May 2017
  • April 2017
  • March 2017
  • February 2017
  • January 2017
  • December 2016
  • November 2016
  • October 2016
  • September 2016
  • August 2016
  • July 2016
  • June 2016
  • May 2016
  • April 2016
  • March 2016
  • February 2016
  • January 2016
  • December 2015
  • November 2015
  • October 2015
  • September 2015
  • August 2015
  • July 2015
  • June 2015
  • May 2015
  • April 2015
  • March 2015
  • February 2015
  • January 2015
  • December 2014
  • November 2014
  • October 2014
  • September 2014
  • August 2014
  • July 2014
  • June 2014
  • May 2014
  • April 2014
  • March 2014
  • February 2014
  • January 2014
  • December 2013
  • November 2013
  • October 2013
  • September 2013
  • August 2013
  • July 2013
  • June 2013
  • May 2013
  • April 2013
  • March 2013
  • February 2013
  • January 2013
  • December 2012
  • November 2012
  • October 2012
  • September 2012
  • August 2012
  • July 2012
  • June 2012
  • May 2012
  • April 2012
  • March 2012
  • February 2012
  • January 2012
  • December 2011
  • November 2011
  • October 2011
  • September 2011
  • August 2011
  • July 2011
  • June 2011
  • May 2011
  • April 2011
  • March 2011
  • February 2011
  • January 2011
  • December 2010
  • November 2010
  • October 2010
  • September 2010
  • August 2010
  • July 2010
  • June 2010
  • May 2010
  • April 2010
  • March 2010
  • February 2010
  • January 2010
  • December 2009
  • November 2009
  • October 2009
  • September 2009
  • August 2009
  • July 2009
  • June 2009
  • May 2009
  • April 2009
  • March 2009
  • February 2009
  • January 2009
  • December 2008
  • November 2008
  • October 2008
  • September 2008
  • August 2008
  • July 2008
  • June 2008
  • May 2008
  • April 2008
  • March 2008
  • February 2008
  • January 2008
  • December 2007
  • November 2007
  • October 2007
  • September 2007
  • August 2007
  • July 2007
  • June 2007
  • May 2007
  • April 2007
  • March 2007
  • February 2007
  • January 2007
  • December 2006
  • November 2006
  • October 2006
  • September 2006
  • August 2006
  • July 2006
  • June 2006
  • May 2006
  • April 2006
  • Show More
June 5, 2019 10:42AM

A Benevolent Central Bank

By James A. Dorn

SHARE

It has become clear that Fed Chairman Jerome Powell will do whatever it takes to keep the expansion going.  In early January, the stock markets rallied after Mr. Powell softened his rhetoric and promised “patience” in setting the federal funds target range.  Initially, the Fed was to be on “autopilot” and proceed with two rate hikes this year.  That promise was called off because of slowing global growth and the fear that higher rates would cause a sharp fall in asset prices. 

Now the chairman has excited markets by announcing at the Chicago Fed conference that “we will act as appropriate to sustain the expansion”—meaning that a rate cut could be in the cards possibly as early as July.  That sentiment was expressed earlier by St. Louis Fed President James Bullard. 

Currently, the effective fed funds rate is above the 10-year Treasury rate of 2.07 percent—and the yield curve is inverted, normally a sign of impending recession.  To restore a positive slope to the yield curve, the Fed would have to pencil in two 25 basis point cuts in its policy rate target range, which now stands at 2.25 to 2.50 percent.

But what if the decline in long-term rates reflects a growing uncertainty about the impact of trade wars on productivity and growth, which is driving investors worldwide to hold U.S. government bonds as a safe haven?  When the demand for U.S. bonds increases, their prices rise and yields fall.  By lowering the fed funds target, the U.S. central bank would divert attention from the trade conflict and the uncertainty it generates.

The Fed would simply restore the yield curve to its normal positive slope, and pretend that its “lower-for-longer” interest rate policy can create a permanent wealth effect.  The Fed also seems ready to return to large-scale asset purchases (quantitative easing) if short-run nominal rates approach zero.

It is true that core inflation, as measured by the price index for personal consumption expenditures, is low. But asset price inflation is not low. It has been fanned by the Fed’s policy of holding real rates close to zero or even negative.  Should the key policy of the central bank be to encourage risk taking by suppressing interest rates?  There is nothing in the Federal Reserve Act that says so.

Moreover, as Vincent Reinhart, chief economist at Mellon Investments Corp., writes in the current issue of the Cato Journal: “How can we expect traders and investors to react reliably to shocks in the future if their past is one in which they have been protected by a benevolent central bank?”

If the Fed followed a credible monetary rule, such as keeping nominal GDP on a level growth path and making up for misses, total spending would be a better guide to the stance of monetary policy than interest rates.  Interest rates are key intertemporal relative prices that should be allowed to adjust freely according to market forces—not be set by a small group of “experts” at the Fed. 

The Fed is rapidly losing its independence by catering to financial markets and seemingly to the White House.  If the Fed were subject to a nominal GDP rule, say a 5 percent growth target, financial market volatility would lessen.  Last December the Fed made a mistake by raising its policy rate target range and stock prices tanked.  That volatility could have been avoided if nominal GDP had been the target, because total spending was growing at about 5 percent.

By doing whatever it takes to keep the expansion going, the Fed risks further inflating asset prices while fleecing seniors who depend on interest income from their savings.  The Fed’s backstopping of stock markets and big government, by pegging   interest rates at low levels, will also further politicize monetary policy and encourage protectionist trade policy.

If the Fed could actually stimulate real economic growth by financial repression (i.e., by engineering negative real interest rates), then Congress would have little to do except to make sure the monetary printing presses were operating at maximum capacity.

The real problem today is not that there is too little inflation but that there is too much discretion in both monetary and fiscal policy.  Moving to a rules-based monetary regime, reducing the size and scope of government, allowing markets not the Fed to allocate credit, and addressing structural issues would help set the basis for long-run economic growth and prosperity.  Turning over all policy levers to the Fed is not a viable solution.

Stay Connected to Cato

Sign up for the newsletter to receive periodic updates on Cato research, events, and publications.

View All Newsletters

1000 Massachusetts Ave. NW
Washington, DC 20001-5403
202-842-0200
Contact Us
Privacy

Footer 1

  • About
    • Annual Reports
    • Leadership
    • Jobs
    • Student Programs
    • Media Information
    • Store
    • Contact
  • Podcasts

Footer 2

  • Experts
    • Policy Scholars
    • Adjunct Scholars
    • Fellows
  • Events
    • Upcoming
    • Past
    • Event FAQs
    • Sphere Summit

Footer 3

  • Publications
    • Books
    • Cato Journal
    • Regulation
    • Cato Policy Report
    • Cato Supreme Court Review
    • Cato’s Letter
    • Human Freedom Index
    • Economic Freedom of the World
    • Cato Handbook for Policymakers

Footer 4

  • Blog
  • Donate
    • Sponsorship Benefits
    • Ways to Give
    • Planned Giving
Also from Cato Institute:
Libertarianism.org
|
Humanprogress.org
|
Downsizinggovernment.org