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The Mystery of Central Banking / mises.org, engl.

verfasst von - Elli -, 22.07.2004, 23:22

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The Mystery of Central Banking
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Robert P. Murphy

[Posted July 21, 2004]

<img alt src="http://www.mises.org/images3/fed.gif" align="right" border="0" width="183" height="230">With
the recent rate hike, the mainstream press obediently
parrots the macroeconomic analysis offered by our friendly central planners at
the Federal Reserve. The average citizen knows that he or she is not
nearly smart enough to understand the complex interrelationships of various
price indices, yield curves, consumer confidence, and so forth—that’s
Greenspan’s job.

But the basic story, as told by our wise overseers,
runs something like this: A high interest rate keeps prices down, but
stifles business and prolongs unemployment. On the other hand, a low
interest rate stimulates output and hiring but causes inflation. It is
the job of the central bank to pick an interest rate j-u-u-u-st right, to
achieve the optimal balance between these two extremes. (Indeed, I once read a
financial analyst who actually used the term"Goldilocks" in
describing Fed policy.) A good central banker knows when to cut rates to
jump start the economy out of a recession, but he also has the courage to
"apply the brakes" by hiking rates when the economy begins to"overheat."

Standard Macro Models are Nonsense

As you may have inferred from my tone, I reject this
popular analysis as utterly crude and pernicious. In a market economy, the
interest rate is not merely a lever to stimulate or depress economic growth,
and the connection between interest rates and inflation is far more subtle
than the standard story suggests. The price of borrowing money has a"correct"
value just as the price of a pair of shoes; the government cannot tinker with
this value willy-nilly without causing drastic distortions.

Even putting aside theoretical objections (which we
will analyze more fully below), the standard macroeconomic story has no
historical support. The most obvious example is the Great Depression itself,
which occurred a good fifteen years after the Federal Reserve had been
established to ostensibly dampen the vicissitudes of the wildcat free market.

In the 1970s, the <ST1:COUNTRY-REGION>
<ST1:PLACE>
US</ST1:PLACE>
</ST1:COUNTRY-REGION>
experienced"stagflation," i.e. simultaneous double-digit
unemployment and inflation. This was impossible according to the
prevailing Keynesian orthodoxy, the equivalent of an economy that was both
stuck in a rut and overheating at the same time.

More recently, Japanese policymakers were stumped in
the 1990s when they couldn’t improve their lackluster growth, despite
nominal interest rates that were very close to or even literally zero percent.
At that point, they had hit a wall; you can’t cut rates lower than zero,
since lenders would do better to stick their funds under a mattress. (I saw a
lecture by Paul Krugman in which he told us that his advice to the Japanese
central bankers had been to credibly announce very high rates of future
inflation, which would cause the real rate of interest in <ST1:COUNTRY-REGION>
<ST1:PLACE>
Japan</ST1:PLACE>
</ST1:COUNTRY-REGION>
to become negative.)

As these historical episodes illustrate, even the
staunchest proponent of central banking would have to concede that it is more
an art than a science."Exogenous" parameters in macroeconomic
models can always change, such that the"optimal" policy move turns
out, in retrospect, to be dead wrong. But isn’t this true in all fields?
Shouldn’t we just give the macroeconomists more time to accumulate
statistics and generate even more sophisticated mathematical models?

No, we shouldn’t give the policy wonks another decade
to tinker, because in this case it is the arrogant and ignorant mismanagement
of the central bankers itself that is the major source of macroeconomic
instability. As with other areas of government meddling in the economy,
political"remedies" only serve to exacerbate (or indeed, often cause)
the very problems they supposedly solve.

An Analogy

To appreciate the damage wrought by central banking, it
may help to change the context in order to break free of habitual modes of
thought. To that end, imagine that there is no Federal Reserve System,
but rather a Federal Housing System. This organization is entrusted with
a printing press, with which it can literally run off perfectly legal, crisp
$100 bills. Every month, the Fed prints new greenbacks and distributes
them to a select group of housing developers, giving the new money in
proportion to how many houses a particular builder constructs in a given
period. This privileged group then uses the newly printed money (in
addition to other funds) to buy lumber, bricks, etc. and to hire workers to
construct new houses, which are then sold to homeowners in the normal fashion.

What would be some of the major effects of this
hypothetical arrangement? Well, the newly injected $100 bills would allow
the builders to bid up the prices of lumber and other materials, siphoning
these resources away from other uses, and causing more homes to be built than
would otherwise have occurred. Especially on the heels of a bigger than
expected injection of cash, there would be an apparent boom in the housing
industry, as builders increased their orders for materials and hired more
laborers to complete their projects. Because of the government subsidy,
the housing industry would be more profitable than before, and competition
among builders would eventually lead to a fall in housing prices for consumers.

Of course, running off new $100 bills from the Fed’s
printing press would cause a rise in the price level, first in the prices of
lumber, shingles, windows, etc., but eventually in the prices of all
goods and services, as the extra cash worked its way throughout the entire
economy. The people running the Federal Housing System would soon learn
that if they injected too much cash too quickly, it would cause massive
dislocations in other industries (which need lumber, laborers, etc. too) and
would lead to unacceptably high rates of price inflation. Of course, it
would be very painful and disruptive to stop the printing press altogether,
since this would put many builders out of business and cause a spike in
housing prices. After such policy reversals, entire neighborhoods of
half-built houses would be abandoned, serving as stark reminders of wasted
resources.

After the Federal Housing System had been in place for
some time, the private sector would become better at anticipating its actions. Analysts
would devote their entire careers to parsing the casual remarks by Fed leaders,
and would run statistical tests on the data used by the Fed to determine how
much cash to print in the upcoming months. (For example, perhaps the Fed
would look at new homes per capita, or the rate of housing growth compared to
inflation, in order to determine its"target price" for new homes.) As
people came to expect the monthly injections of cash, the Federal Housing
System would become less and less able to influence events. In order to
boost employment, for example, the Fed would have to inject ever higher
amounts of cash, in order to catch the ever savvier home builders by surprise
and make their projects more profitable than they had originally reckoned.

Naturally, certain groups would have a vested interest
in either high or low rates of money injection. Young couples, for
example, would clamor for the Fed to print out more cash and push down the
price of a new house. Older couples who held no mortgage, on the other hand,
would write Letters to the Editor urging restraint on the part of the Fed,
since they would want their older homes to retain their market value. In
this environment, it would be up to the technocratic economists to advise the
Fed on a fair and sensible amount of money injection to the housing industry,
which would best balance the desires of everyone.

The Real World

I hope most readers will agree that the hypothetical
Federal Housing System would be a horrible idea. In the long run, it
would be far better for everyone involved—even new home buyers—to
eliminate the extra source of uncertainty and political manipulation in the
housing industry by abolishing the FHS. Freely established market prices
would foster the best use of scarce resources to satisfy consumer desires,
whether for housing, fancy dinners, or automobiles.

But if the reader has agreed with me thus far, then he
or she must also endorse the abolition of the Federal Reserve System. Despite
the mysticism of central banking, and the awe with which we mere mortals
behold Alan Greenspan, there is no major difference between central banking in
the <ST1:COUNTRY-REGION>
<ST1:PLACE>
US</ST1:PLACE>
</ST1:COUNTRY-REGION>
, and the hypothetical scenario I invented above.

After the Federal Reserve sets a"target interest
rate," it achieves its goal by (among other things) literally creating
money out of thin air. The process is obscured through intermediate steps
(such as"open market purchases" of securities), but ultimately the
Federal Reserve creates new deposits for major banks out of an accounting
vacuum, and then allows its privileged clients to use these new deposits as
the collateral with which the client banks issue new credit to borrowers. Because
borrowers will seek a larger quantity of credit only at lower interest rates,
the Fed can indirectly influence the various market rates of interest by
controlling the amount of credit that its client banks can ultimately loan.

All of the effects described above (for the Federal
Housing System) occur under the Federal Reserve System, except that in the
latter case the damage is more widespread, since the credit markets affect
virtually all industries. Rather than printing up new cash and handing it
out to large home builders, in effect the Federal Reserve prints up new cash
and hands it out to privileged lenders. The hypothetical Fed stimulated
housing construction, but the real Fed stimulates all industries that
engage in long-term projects.

As explained by the Austrian theory of the business
cycle, the interest rate serves to coordinate the intertemporal structure of
capital goods. To put it simply, a high interest rate is a signal to
producers that consumers are"impatient" and place a premium on
production processes that involve a relatively short gestation period. A
low interest rate, on the other hand, is a green light to producers to invest
in processes that tie up resources for a longer period. (Notice that a
process in which resource costs are rolled over for, say, ten years will be
more sensitive to the interest rate than a process in which resource costs are
recouped by the final sale after, say, two years.)

Depending on factors such as technology, the supplies
of various capital goods, and the willingness of consumers to postpone
immediate consumption in order to enjoy higher consumption in the future, the
Austrians believe that there is a"correct" market rate of interest
at any given time (for loans with a specified level of risk). But a
central bank interferes with the market’s natural tendency to achieve these
correct rates. In order to keep voters happy, the central bank habitually
pushes rates lower than they ought to be, which causes the familiar boom
period in which stock prices soar and unemployment falls. But this
artificial expansion is unsustainable, and inevitably leads to a bust period,
in which many of the production processes must be curtailed or abandoned
altogether, and workers in these lines must be laid off.

Conclusion

A short article such as this one cannot of course
explain the subtle features of Austrian business cycle theory; the
interested reader should consult Mises’s discussion in Human Action. However,
I hope that my analogy of the Federal Housing System has alerted the reader to
the problems of our current arrangement. We will never rid ourselves of
the boom-bust cycle until we remove our monetary and banking institutions from
political manipulation, and return them to private individuals operating in a
voluntary market. In light of the more sophisticated Austrian analysis,
the standard macro theories regarding Fed policy and interest rates are
hopelessly naïve and destructive.

____________________________

Robert Murphy is an adjunct scholar of the Mises
Institute. He teaches economics at Hillsdale College. robert_p_murphy@yahoo.com.
See the Murphy Archive.
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The Mystery of Central Banking / mises.org, engl. - - Elli -, 22.07.2004, 23:22