The
Magnificent Seven
Knuckle merchants and your bankers too
Must get up and learn those rules
Weather man and the crazy chief
One says sun and one says sleet
Bankers have rules, even if you don’t understand their rules.
Central banks are supposed to inspire confidence in the
economy by keeping inflation low and stable. America’s Federal Reserve has
suffered a hair-raising loss of control.
https://www.economist.com/leaders/2022/04/23/why-the-federal-reserve-has-made-a-historic-mistake-on-inflation
This is true ONLY if you believe that America’s Federal
Reserve bank actually HAS the ability to keep inflation low. The Federal
Reserve bank is responsible for maintaining a medium of exchange that allows
trade in the US economy to take place. Prior to the establishment of central banks,
such as the Federal Reserve, individual banks were a place to store currency. However
they did not, should not, only store currency. They also lend that currency (i.e.
make loans). This creates a problem with liquidity for individual banks. If a
bank has loaned currency, that currency can not immediately be returned to its depositors.
If depositors demand a return of their currency, it can exceed the amount of deposits,
reserves, the bank has on hand. That is what a bank run is all about. And bank
runs undermine the confidence in a currency as a medium of exchange. The Federal
Reserve Bank serves as a central clearing house such that runs on banks will
not happen. It monitors the total amount of money needed by the economy, and
lends currency to those individual banks in order to maintain their liquidity
and prevent bank runs.
The Federal Reserve does this by making loans to individual
banks. Those loans have to repaid by those banks in the future. If
there should be a discount rate that is applied to the future then this should be
considered in the interest rate. That the future is worth less than the present
is popular wisdom, “A bird in the hand
is worth two in the bush,” and Biblical wisdom, Matthew 25:14-30, the Parable of the Talents. Charging
an interest rate effects not only the repayment of the liquidity. If that liquidity
is used to increase production (investment) or consumption (borrowing), it can
have an effect on the price of goods, inflation. However that is NOT the only way
that prices can increase. Consumer preferences can change (e.g. today’s demand for
buggy whips is not like that of the 19th century), or the things unrelated
to the interest rate can change the cost of goods (e.g. a ship can get stuck in
the Suez Canal, droughts or wildfires can happen, a global pandemic can occur, Russia
can invade Ukraine, etc.).
The Federal Reserve can and has maintained a stable domestic
currency . It has not created more currency
(money) than is needed for trade, unlike the Weimar republic or other examples
of hyperinflation. It cannot prevent ordinary inflation. This is like blaming
the weatherman if it rains. Don’t shoot the messenger.
That there has been persistent inflation since the 1970s
is not due to the Federal reserve’s failure to responsibly monitor the domestic
US economy. It is because when a domestic currency is also used as the unit of international
trade, this leads to tension between national and global monetary policy, i.e. the
Triffin Dilemma. https://dbeagan.blogspot.com/2018/08/the-happening-riding-high-on-top-of.html
The fact that inflation has been manageable is a testament to the Federal
Reserve’s success. That it can not prevent all inflation should not be deemed
its failure. You don’t have to love banks, to accept that you need banks.