New Op-Ed on Expanding the Fed's Regulatory Powers

The Cato Institute has just published an op-ed of mine titled Giving the Fed New Powers Ignores History.

Summary:

Like the child who murders his parents and then asks for pity because he's an orphan, the Federal Reserve has a long history of asking for more regulatory powers to clean up messes for which its action or inaction is the primary cause….

The history of banking in the United States and elsewhere does not show that the industry is beset by market failures that require regulatory intervention. To the contrary, almost every major crisis faced by the banking system has been the consequence of already-existing regulations, many of which came about as responses to previous crises caused by older regulations. Countries, like Canada, where some of the worst of these regulations were absent, have not had the same history of crises as has the United States. Perhaps this time we will learn from history and avoid a new regulatory regime that will create new threats to an already somewhat shaky U.S. financial system.

Cross-posted at Liberty and Power.

Comments

[Roger Koppl]

Nicely done, Steve. Congratulations on a fine piece touching on an important and basic point. As you know, Mises pointed out the tendency of one regulation to create problems that are answered with more regulations, that create problems . . .

[Steve Horwitz]

Yeah Roger, that sounds vaguely familiar. ;)

[Bogdan Enache]

"...regulations of the National Banking System...which had the effect of making it difficult for banks to expand the money supply when the demand for currency rose due to harvest season needs or because customers wished to leave troubled banks. "

Harvest season comes every year, thus fluctuations in the demand for money can presumably be anticipated within reasonable margins by bankers and farmers alike, can't they not? And if customers wished to leave troubled banks, what can one do?...

[Steve Horwitz]

The banks couldn't do much when they couldn't find the required bonds to back up their currency issues at a price that made doing so financially prudent. Plus, it often took up to 6 weeks to actually get the notes printed and delivered, which happened in DC despite the fact that they were liabilities of the banks.

The harvest season needs did fluctuate year to year in their intensity and when they happened alongside folks wanting to leave troubled banks, the banks could not get the currency they needed to meet those demands. This is a pretty standard story among monetary historians.

[matthew mueller]

Thanks to Dr. Horwitz for bringing back economics!

This short article was a great review for me of a course I took with Dr. Lawrence White last Fall at UMSL.

1.) Rather than making an argument, I would like to ask some questions. What is the Austrian position on the theory of endogenous money?

Once we accept the claim that money is NOT an "outside" variable that is directly controllable by monetary authorities, then the concern over increasing demands for money seems to fall from view. We live in a credit economy. Debts are created for investment, and financial institutions service this debt by increasing in every way their lending capabilities. This is hardly controversial. But few economists have extended the implications of it.

Now you can dismiss the "post-Keynesian" theory of endogenous money because other notable economists have done so (for example, see Brunner and Meltzer's book 'Money and the Economy') but I think their understanding of this theory is confused. And I admit that I am not at all clear (yet!) on it either. But from the few books I have read (Kaldor's Scourge of Monetarism, Rousseas' Post Keynesian Monetary Economics, King's History of P.K. Economics since 1936, etc.), the theory seems to suggest that central banks are responsible for accomodating the "needs of trade." How this is done is disputed even among Post Keynesians. One can reverse the Quantity Theory of Money, like Weintraub, and argue that money increases in response to rising prices according to the Wage Theorem, or one can argue, like Kaldor, that increases in the demand for money are met through a combination of central bank policies, increases in velocity, and institutional changes that increase lending ability (mutual funds, sweep accounts, the Eurodollar market, etc. etc.). But the basic idea is that a sophisticated credit economy destroys completely conventional accounts of monetary theory which attempt to control the money supply either directly or through interest rate changes. High interest rates are not sufficient obstacles to the creation of new money. Financial innovations will respond to these changes.

Now I am afraid that you will brush all this away in one sentence. Please do not do that. I would be happy to continue this discussion through private email. Or you can forward it to Dr. White. I am very persuaded by Post Keynesian monetary economics. But I also recognize that I do not fully understand it yet. Before I make that leap of faith, why not try to dissuade me from it?

Thanks!

[Steve Horwitz]

Matt,

I'm not sure there is "an" Austrian position on the theory of endogenous money. I think the argument of the free bankers is that money *should be* endogenous to the demand to hold it. Whether it *is* endogenous under central banking is a different question. What I'm comfortable saying is that central banks cannot totally control the quantity of money and thus the amount ultimately supplied depends on the decisions of market participants (e.g, their preferred currency/deposit ratios) and individual banks (e.g., their preferred level of excess reserves). If that makes money endogenous, so be it.

An interesting paper that compares my own work to that of the post-Keynesians on this very issue is here: http://www.tau.ac.il/~june/endogenous.doc