Thursday, October 20, 2011

Ron Paul Blames the Fed

Ron Paul laid out his critique of the Fed today in the Wall Street Journal. He's absolutely right on some points:
The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.
However, his argument rest on an odd premise:
The Federal Reserve has caused every single boom and bust that has occurred in this country since the bank's creation in 1913.
But what about every single boom and bust before 1913? The U.S. tried various monetary arrangements, including decentralized money (state-issued), silver-backed currency, gold-backed currency, having a National Bank, not having a National Bank... and they all gave more or less the same result. It's true that the Fed hasn't fixed all our problems, as Christina Romer showed. But when Paul advocates returning to the Gold Standard, he seems to claim that the Golden Age will have no recessions and no booms. That's absurd.

It's surprising to economists that the Fed is capable of controlling market interest rates with a tiny lever; but it does so. That tells us that the fundamentals underlying interest rate determination in a free market are weak. If free-market interest rates were solid, steady, and grounded, then a little overnight lending rate would barely be able to budge them. Thus, I look at financial markets and conclude that interest rates would in all likelihood be volatile and unpredictable in a free market, leading to malinvestment, booms, and busts in much the way that Paul describes.

Gold is not the answer.

1 comment:

Anonymous said...

Obviously, we need to all switch to Bitcoins.