The Fed’s 100th year birthday

Fiat Money

Modern fractional reserve central banking seems to be a great improvement to the prior fragmented US regime. Though the Great Depression of the 1930s forced some tinkering with this system, in particular introduction of the FDIC to federally guarantee deposits and Keynesian prescriptions to address chronic unemployment, the system has worked exceedingly well.

So central banking had evolved from being on the gold standard in prior centuries, to fragmented fractional reserve banking, to fully fiat money central banking (when the gold standard was officially abandoned in 1971.)

There is nothing conceptually wrong with fiat money. Paul Volcker demonstrated in 1979 and the years following that adept maneuvering and resolve by a strong Fed Chair could make fiat money as good as, or better than, gold. Under Alan Greenspan and Bernanke, the Fed formalized the intuitive discipline of Volcker’s policies by elevating analytic methods of inflation targeting to the forefront [4]. In effect, inflation targeting replaces the single commodity--gold--with a basket of commodities and other traded and consumption goods. The CPI, or more specifically CPI plus 2 percent per annum, becomes the numeraire. Bernanke’s academic works suggest that the Fed’s “dual mandate” to manage both inflation and unemployment can be optimized through inflation targeting. Countless papers on macroeconomics, modern monetary theory, and central banking, establish this as the current economic state-of-the-art, political realities and implementation challenges aside.

Conspiracy theories abound. The bureaucratic structure of the Fed is complex. It is simultaneously “independent” but “within the government.”[5] Ownership of the operating arms is conceptually vested in member banks of the Federal Reserve System[6], but the President of United States, and US Congress, respectively appointing Chair of the Board of Governors and legislate the laws governing the Fed. Even though the CPI is calculated by the BLS rather than the Fed, the Fed more so than even the BLS, draws criticism for CPI calculation methodology, and modifications to it. The CPI is being attacked by those who think it is too subjective and those who think it is too mechanical.

Ultimately, like all major US institutions, the Fed is run under an implicit license of the US government, the body politic or ultimately, therefore, the country’s populace. Like all successful democratic bureaucracies, its endurance is assured by the web of interactions between its rules, regulations, practices, personnel, and appointments with the outside world that govern its daily operations and longer term policies.

For 99 years, this generally has worked well. Though inflation has fluctuated and crises involving gold (in 1933 and 1971), the misery index (combination of high unemployment and high inflation in the 1970s), and occasional major bank failures have come and gone, the Fed has endured.[7] Most recently, the Fed has received high marks for doing “whatever it takes” to put a floor beneath the US economy after the bubbles in housing, banking, finance and employment imploded in 2008.

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