Does the Federal Reserve cause inflation?

Great Debates
21

[QUOTE=Measure for Measure]
Agreed.

I’m arguing that the economies of the 1870s were rather different than, say, the 1970s, owing to the large share of the labor force that were tied to farming.
[/QUOTE]

But we didn’t go off the gold standard until the 1930s, so if your argument is that a largely industrial nation can’t survive on the gold standard, then that’s the more relevant date. Besides, it’s not so much how many people are employed in agriculture that matters but what percent of GDP it represents, if you argument is about the economy itself.

22

Fair enough: I haven’t really spelled out my argument (or pulled it out of my memory for that matter).

Briefly, I’m saying that changes in the labor market from around 1870-1930 made the economy more vulnerable to economic shocks. Put another way, the aggregate supply curve became flatter. We went off the gold standard because it wasn’t working too well.

Specifically a greater share of the labor market became covered by largely implicit employee-employer arrangements that made wages sticky downwards.

For example, a family farm’s “wages” will be a direct function of produce prices: these payments for labor are very flexible.

The market for unskilled labor also tends to have flexible wages: if a worker demands too much, it’s easy to get a replacement.

Things tend to be different in large industrial plants. For example, the threat of unionization --or heck sabotage-- tends to bring worker morale issues to the forefront. And workers don’t tend to like nominal wage cuts, even when the general price level is falling.

So I’m saying that a growing service and industrial sector will tend to increase the necessity for counter-cyclical policy, due to reduced wage flexibility in the economy.

There are other arguments. The Fed was criticized for not cutting interest rates fast enough from 1929-1933. But they were constrained by the necessity of keeping dollars convertible to gold (higher interest rates make bank deposits more attractive than gold, which does not earn interest).

Most countries said the hell with it and went off the gold standard in 1931-32: by Dec 1932 only the US, France, Belgium, Switzerland and the Netherlands remained attached to gold: the US would cave about 3 months later IIRC.

Incidentally, the gold standard of the 1920s apparently differed from earlier institutions in important ways. A given amount of gold supported a greater amount of money as a result of 2 mechanisms. First, outside of the US gold coins were removed from circulation: only gold bars could be redeemed. This put more gold in the hands of the central banks.

Second, a number of countries held a portion of “gold reserves” in foreign currencies that were themselves tied to gold. That was all fine and well, but if some of these banks attempted to convert their foreign reserves back into gold, the world financial system would experience a deflationary monetary contraction.

(Facts pulled from Chandler, America’s Greatest Depression, 1970).

23

Come to think of it, why do they still keep all that gold at Fort Knox? What’s it for?

24

[QUOTE=DrCube]
Can you elaborate a little? I’m particularly interested in what you mean by gold-backed money being “honest”. I suppose trust money is “dishonest”?
I learned in macroeconomics that the Fed uses monetary policy to keep the economy between extremes of the business cycle. One extreme is a recessionary gap, where potential GDP minus real GDP is a positive number; apparently this is when unemployment is high. The other extreme is an inflationary gap where potential GDP minus real GDP is a negative number; this is when inflation is high. By trying to keep the economy “walking the line” so to speak, the Fed needs there to be a little inflation, so I could see this being construed as “the Fed causes inflation”.

But I don’t really know anything, sorry.
[/QUOTE]

When I took macroeconomics, they didn’t bother telling us about the history of banking and money. It seems they really don’t want people to understand about money, but they do want to indocrinate them about how the Fed “heroically” keeps the economy on track.

Suppose you have some gold coins that you feel uncomfortable keeping around the house lest some thieves take them. You go to someone who has a large secure building with a a vault that offers to take your coins and gives you a reciept saying “redeemable for 1 ounce of gold”. Thieves could still take the reciepts of course, but the paper proves to be more conveinient to use rather than coins. Instead of using coins, people start trading the pieces of paper as if they were gold. After a while the banker realizes he can loan out pieces of paper, since not everyone has wanted to trade in their reciepts at the same time. Pretty soon there more pieces of paper circulating that promise to be redeemed by gold than there is gold in the banker’s vault. When word spreads that the bank doesn’t have enough gold to back up all the paper reciepts, people holding the banknotes stampede to the bank demanding to get their gold.

This is how fractional reserve banking came about, only a fraction of the money in circulation is backed by a tangible asset. The whole Fed saga starts with some gold backing the money, but they gradually eliminated gold.

Honest money is something that either is a physical piece of metal, or is redeemable for a physical piece of metal.

Look at the current issue about our pennies. They haven’t been all copper for years, but even now the little copper content in them is worth much more than 1 cent. Classic example of monetary debasement. Same thing happened in 1964 when they went from all silver coins to silver clad coins.

Here is a good link that explains the history of our money:
http://www.friesian.com/notes.htm

There are plenty of other web sites that explain how the Federal Reserve is a big scam, unfortunately some sites get kind of wacko.

25

[QUOTE=ex747mech]
When I took macroeconomics, they didn’t bother telling us about the history of banking and money. It seems they really don’t want people to understand about money, but they do want to indocrinate them about how the Fed “heroically” keeps the economy on track.
[/quote]

:dubious: You’re asserting that economics profs are part of a government propaganda machine or something. Have you got anything to back this up?

[QUOTE=ex747mech]
Suppose you have some gold coins that you feel uncomfortable keeping around the house lest some thieves take them. You go to someone who has a large secure building with a a vault that offers to take your coins and gives you a reciept saying “redeemable for 1 ounce of gold”. Thieves could still take the reciepts of course, but the paper proves to be more conveinient to use rather than coins. Instead of using coins, people start trading the pieces of paper as if they were gold. After a while the banker realizes he can loan out pieces of paper, since not everyone has wanted to trade in their reciepts at the same time. Pretty soon there more pieces of paper circulating that promise to be redeemed by gold than there is gold in the banker’s vault. When word spreads that the bank doesn’t have enough gold to back up all the paper reciepts, people holding the banknotes stampede to the bank demanding to get their gold.

This is how fractional reserve banking came about, only a fraction of the money in circulation is backed by a tangible asset. The whole Fed saga starts with some gold backing the money, but they gradually eliminated gold.
[/quote]

All perfectly true. But what’s wrong with any of that?

[QUOTE=ex747mech]
Honest money is something that either is a physical piece of metal, or is redeemable for a physical piece of metal.
[/quote]

Call that “honest” if you like, but what makes it any better than the current system?

[QUOTE=ex747mech]
Look at the current issue about our pennies. They haven’t been all copper for years, but even now the little copper content in them is worth much more than 1 cent. Classic example of monetary debasement. Same thing happened in 1964 when they went from all silver coins to silver clad coins.
[/quote]

So what?

[QUOTE=ex747mech]
There are plenty of other web sites that explain how the Federal Reserve is a big scam, unfortunately some sites get kind of wacko.
[/QUOTE]

How does anything you’re describing make the Fed a scam?

26

[QUOTE=John Mace]
It’s pretty mainstream thought that The Depression was caused in large part by mismanagement of monetary policy by the Fed.
[/QUOTE]

Cite? I thought that was only one of several theories. (Another theory is that it happened, at least in part, because we had a gold standard at the time, making a “loose money” policy impossible just when it was needed.)

27

[QUOTE=ex747mech]
When I took macroeconomics, they didn’t bother telling us about the history of banking and money. It seems they really don’t want people to understand about money, but they do want to indocrinate them about how the Fed “heroically” keeps the economy on track.
[/QUOTE]

Thanks. I didn’t realize I was being indoctrinated. Pray tell, where did you learn the hidden truth, O enlightened one?

I didn’t realize the purpose of banks was to keep money safe from thieves. I thought they were private businesses that loaned and borrowed money in such a way as to make a profit on the interest. Except for that, I was taught all this in economics. It works just as well with paper money as gold. How are banks supposed to make loans if every customer’s money has to be physically present at all times? This is an issue with or without gold; if you want your money to be there at all times, just get a piggy bank. Or a safe. If you want to make a little interest, you have to allow that the bank might not have all your money on the premises.

Please tell me why it has to be metal. I just don’t get it. Money only has value because we all agree that it does, whether it is metal or paper. It really seems like superstition to insist that it must be shiny metal, but I’m sure you’re not superstitious. I just don’t understand your hangup here.

Here we have an agreement. Money costing more to make than it is worth seems like a waste to me. But we have all that paper money that costs like 30 cents per bill, whether it’s a one or a hundred. Now that’s a bargain!

At first glance, that looks like an interesting site on the history of U.S. currency. I don’t see how it is relevant to discussing the merits of gold-backed currency, though. I still don’t see how the Fed is a scam, either, sorry.

28

I don’t know how to keep these dialogues going without things getting messy with all the quotes and requotes.

Quote:
Originally Posted by ex747mech
When I took macroeconomics, they didn’t bother telling us about the history of banking and money. It seems they really don’t want people to understand about money, but they do want to indocrinate them about how the Fed “heroically” keeps the economy on track.
>> BrainGlutton: You’re asserting that economics profs are part of a government propaganda machine or something. Have you got anything to back this up?<<<

If you wanted people to understand economics, surely you would want them to understand about money. I’m not saying there is a conspiracy, just a failure of the educational system to educate people about money, which is obvious when you start asking people about what those magical green pieces of paper represent.

Quote:
Originally Posted by ex747mech
Suppose you have some gold coins that you feel uncomfortable keeping around the house lest some thieves take them. You go to someone who has a large secure building with a a vault that offers to take your coins and gives you a reciept saying “redeemable for 1 ounce of gold”. Thieves could still take the reciepts of course, but the paper proves to be more conveinient to use rather than coins. Instead of using coins, people start trading the pieces of paper as if they were gold. After a while the banker realizes he can loan out pieces of paper, since not everyone has wanted to trade in their reciepts at the same time. Pretty soon there more pieces of paper circulating that promise to be redeemed by gold than there is gold in the banker’s vault. When word spreads that the bank doesn’t have enough gold to back up all the paper reciepts, people holding the banknotes stampede to the bank demanding to get their gold.

This is how fractional reserve banking came about, only a fraction of the money in circulation is backed by a tangible asset. The whole Fed saga starts with some gold backing the money, but they gradually eliminated gold.

>>BrainGlutton: All perfectly true. But what’s wrong with any of that?<<<

That is a clear case of fraud. If I gave you a coupon that says if you come to my store I will give you something, but then don’t deliver, they will throw me in jail.

Quote:
Originally Posted by ex747mech
Honest money is something that either is a physical piece of metal, or is redeemable for a physical piece of metal.

>>BrainGlutton: Call that “honest” if you like, but what makes it any better than the current system?<<<

If we had honest money, the government can’t borrow trillions of dollars so it can fight unjust wars, turn generations of families into welfare dependants, subsidize corporations, etc.
Quote:
Originally Posted by ex747mech
Look at the current issue about our pennies. They haven’t been all copper for years, but even now the little copper content in them is worth much more than 1 cent. Classic example of monetary debasement. Same thing happened in 1964 when they went from all silver coins to silver clad coins.

>>>BrainGlutton: So what?<<<

That is another clear case of fraud. Ever wonder why coins have the ridges around the perimeter? That is so people can’t shave off metal from the edges and eventually have a new pile of precious metal, in addition to a bunch of coins that still represent the same face value. Of course the ridges are not needed with our debased currency today, it is a tradition that has never be abandoned.
Quote:
Originally Posted by ex747mech
There are plenty of other web sites that explain how the Federal Reserve is a big scam, unfortunately some sites get kind of wacko.

>>>BrainGlutton: How does anything you’re describing make the Fed a scam?<<<

They issue fiat currency, and they even admit it:
“Fiat money is similar to representative money except it can’t be redeemed for a commodity, such as gold or silver. The Federal Reserve notes we use today are an example of fiat money. In 1967 Congress authorized the US Treasury to stop redeeming silver certificates in silver dollars or bullion beginning the following year. By 1970 silver was removed from the production of coins. The old coins were gradually removed from circulation and replaced with new copper-cored coins that were faced or “clad” with layers of an alloy of 75 percent copper and 25 percent nickel—the same alloy used in nickels.
People are willing to accept fiat money in exchange for the goods and services they sell only because they are confident it will be honored when they buy goods and services. The Federal Reserve is responsible for maintaining the integrity of US currency by setting monetary policy —controlling the amount of money in circulation—to keep prices stable. If prices remain stable, people have confidence that the dollar they use to buy goods and services today will buy a similar amount in the future.”
http://www.minneapolisfed.org/econed/curric/history.cfm

People have 100% confidence that gold is gold, but when banks and governments collude to create money out of debt, people’s confidence becomes fickle.

The scam part is when the national debt, what “you and I” as taxpayers owe holders of treasury securities, is inflated to unredeemable amounts. The federal reserve creates money out of thin air to buy securities, you and I have to earn money to buy securities.

29

[QUOTE=ex747mech]

They issue fiat currency, and they even admit it:
“Fiat money is similar to representative money except it can’t be redeemed for a commodity, such as gold or silver. The Federal Reserve notes we use today are an example of fiat money. In 1967 Congress authorized the US Treasury to stop redeeming silver certificates in silver dollars or bullion beginning the following year. By 1970 silver was removed from the production of coins. The old coins were gradually removed from circulation and replaced with new copper-cored coins that were faced or “clad” with layers of an alloy of 75 percent copper and 25 percent nickel—the same alloy used in nickels.
People are willing to accept fiat money in exchange for the goods and services they sell only because they are confident it will be honored when they buy goods and services. The Federal Reserve is responsible for maintaining the integrity of US currency by setting monetary policy —controlling the amount of money in circulation—to keep prices stable. If prices remain stable, people have confidence that the dollar they use to buy goods and services today will buy a similar amount in the future.”
http://www.minneapolisfed.org/econed/curric/history.cfm

People have 100% confidence that gold is gold, but when banks and governments collude to create money out of debt, people’s confidence becomes fickle.

The scam part is when the national debt, what “you and I” as taxpayers owe holders of treasury securities, is inflated to unredeemable amounts. The federal reserve creates money out of thin air to buy securities, you and I have to earn money to buy securities.
[/QUOTE]

Paper money certainly is redeemable for a commodity. I redeem it for just about everything from gasoline to tuna fish on a daily basis. So what is the problem again?

30

Hmm. It looks like we’ve decided this is going to be about gold.
That being the case, a couple of educational links:

  1. Gold Standard : a very nice, comprehensive explanation.
  2. Money Matters: the American Experience with Money, which gets into the rationale with moving away from the gold standard.

And now, Dr Cube, a short summary of the problem from Robert Mundell, the father of the euro:

The problem isn’t so much with paper, which stood in for gold even during the classic gold standard period (1870-1914), although in all cases the reliability of the paper originated in the confidence that it could be exchanged for gold. The problem is with the lack of the second part of the phrase “gold standard”: there is no standard way, today, to value a currency. Some are formally fixed to the dollar: the remnimbi. Some are informally fixed: the rupee, the yen - which is allowed to depreciate (as is happening now) but is not allowed to appreciate beyond whatever point the BOJ decides is unacceptable. Others float: the euro, sterling and the currencies of just about all of the UK’s former colonies, even South Africa, and the Swiss franc, among others.
This is inherently unstable, and the result is the huge imbalance that now exists between the US and the rest of the world, that everyone knows needs to be resolved but no one knows how to without causing major grief.
There are other problems. To quote Mundell again:

Eastern Europe is in much better shape now, but the transition was wrenching.
The current monetary system isn’t a system, it’s a mess. It will cause a major disruption soon enough, unless we get some kind of order back into how to handle international balance of payments and currency relationships.

31

The Fed’s record during the first 66 years of its existence, from 1913 to 1979, was disgraceful. It was a monument to human incompetence, giving us the Great Depression of 1929-1941 and the Great Inflation of 1965-1982. Both were far worse than anything we had experienced under a specie standard, combined with private central banking, between 1776 and 1913.

Since then its record has been much better. It still isn’t perfect–I’ve never seen a good reason why our currency needs to depreciate by 3% every year, and I think the Fed could just as easily target 0-1% inflation. However, even a steady 2-3% inflation is better than the oscillations between inflation and deflation experienced under a specie standard, wherein the money supply grows almost randomly in response to mining technology.

I’d prefer to see the Fed adopt Milton Friedman’s suggestion and program a computer to grow the money supply at a rate equal to the long-run growth rate of the economy. In fact, my order of preference for monetary policy would be:

  1. Fed growing the money supply at a constant rate
  2. Fed as it has practiced monetary policy since 1979
  3. Specie standard
  4. Fed as it practiced monetary policy between 1913 and 1979
32

[QUOTE=ex747mech]

Look at the current issue about our pennies. They haven’t been all copper for years, but even now the little copper content in them is worth much more than 1 cent. Classic example of monetary debasement.
[/QUOTE]

Actually, based on the figures in Wikipedia (Penny (United States coin) - Wikipedia), the copper in a penny is worth 4/100 of a cent. The zinc on the other hand is worth 1.07 cents.

The copper in a penny minted bef0re 1982, however, is worth 2.2 cents.

33

[QUOTE=John Mace]
Yeah, no one would invest if there weren’t any inflation.
[/QUOTE]

That’s a nice strawman you’re burning there. Try addressing what I actually posted: inflation encourages investment, not is the only determinant of investment. If you want to argue that the costs of a small amount of inflation outweigh the benefit, that’s fine, and we’re not likely going to resolve that discussion. But please, let’s leave the snarkiness behind(I will admit that I brought it upon myself with that shot at liberatarians).

[QUOTE=Freddy the Pig]
I’d prefer to see the Fed adopt Milton Friedman’s suggestion and program a computer to grow the money supply at a rate equal to the long-run growth rate of the economy.
[/quote]

The Fed(and many other countries) did try Friedman’s suggestion back in the 70s(well, without the computer). As you say, it didn’t work out very well:

34

[QUOTE=ex747mech]
When I took macroeconomics, they didn’t bother telling us about the history of banking and money. It seems they really don’t want people to understand about money, but they do want to indoctrinate them about how the Fed “heroically” keeps the economy on track.
[/quote]
Heh. A capsule history of money is typically given in intro economics. If you want to study the history of banking and money, you might want to take an elective on … Money and Banking. Google provides a lengthy list.

Agreed: some sites get kind of wacko.

Hilarious. The post WWII era represented the greatest period of economic growth the world has ever seen. Even the output stagnation of the 1970s and 80s compared favorably with the 19th century.

Oh, and we had a gold standard until about 1933, which effectively tied the Fed’s hands and arguably intensified the world depression, as I noted above.

Note to the reasonable: at bottom, the question of best monetary practices is a technical one: it’s really not a matter of ideology. For example, imposing a rule that the Fed should grow the money supply at a constant rate has some armchair plausibility. But one should really study the data before pushing this idea. The Fed (and other central banks) tried a monetarist approach during the early Volker era, but backed off of it. The problem is summarized in Goodhart’s Law: “Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes”.

More recently, rules-based advocates have recommended inflation targeting: I have more sympathies for this tactic.

35

[QUOTE=Measure for Measure]
More recently, rules-based advocates have recommended inflation targeting: I have more sympathies for this tactic.
[/QUOTE]

It has certainly proved quite successful here in Canada.

36

[QUOTE=BrainGlutton]
Cite? I thought that was only one of several theories. (Another theory is that it happened, at least in part, because we had a gold standard at the time, making a “loose money” policy impossible just when it was needed.)
[/QUOTE]
I came across an interesting abstract. Bordo, Choudhri and Anna J. Schwartz (1999) argue that small open economies were constrained by the Gold Standard from 1929-1933, but that this didn’t apply to the US at the time. The researchers run a statistical simulation and conclude that, “…expansionary open market operations by the Federal Reserve at two critical junctures (October 1930 to February 1931; September 1931 through January 1932) would have been successful in averting the banking panics that occurred, without endangering convertibility.”

So according to the authors, the Fed could have eased a little more.

Incidentally, the authors also say that the recent consensus view holds, “that the gold standard was the leading cause of the worldwide Great Depression 1929-33”. (That sets up the controversy.)

Some posters will wonder whether the authors have an ax to grind. It’s true that Anna J Schwartz was the author of A Monetary History of the United States, along with her late husband, Milton Friedman. But I see that Bordo was also the co-author of the ironically entitled paper, “The Rise and Fall of a Barbarous Relic: The Role of Gold in the International Monetary System”.

It’s an interesting discussion, once you get past the crowd of loons.

On Preview: I’m not advocating inflation targeting, mind you: I go back and forth on it. But that’s for another thread.

37

[QUOTE=Measure for Measure]
Hilarious. The post WWII era represented the greatest period of economic growth the world has ever seen. Even the output stagnation of the 1970s and 80s compared favorably with the 19th century.
[/QUOTE]
The years of stagflation were roughly from 1965 to 1982. Real economic growth during these years averaged 2.90%. During the 100 years between 1800 and 1900 it averaged 4.13%. Such growth as occurred during the latter years was despite the Fed, not because of it. No one can defend the performance of a monetary authority that allowed inflation to exceed 5% in 12 out of 14 years and reach 13.6% in 1980.

38

[QUOTE=Rysto]
The Fed(and many other countries) did try Friedman’s suggestion back in the 70s(well, without the computer).
[/QUOTE]

Excuse me, that’s my mistake. Canada and the UK tried monetary targeting in the mid-70s, while the Federal Reserve started using it in 1979.

39

[QUOTE=Freddy the Pig]
The years of stagflation were roughly from 1965 to 1982. Real economic growth during these years averaged 2.90%. During the 100 years between 1800 and 1900 it averaged 4.13%.
[/QUOTE]
…mostly due to higher population growth during the 1800s.

Let’s look at living standards, as represented by GDP per capita.



Real GDP per Capita (2000 dollars)

1800  $1237
1900  $4943

1965  $16489
1979  $23037

I chose 1979, because I wanted to start and end near a cyclic peak. Ending with a recession would distort the figures. Plus, Volker changed gears in October 1979, not 1982.

1800-1900: 1.39% per year
1965-1979: 2.42% per year, despite 2 oil shocks and the Vietnam war.

Technical note: Be sure to use a geometric average: a simple average will give comparable growth rates for the 2 periods.

Great link, by the way.

Let’s take a look at the difference between the 2 growth rates over a human generation, 20 years:
1.39% would make the person 31% richer during that period. Pretty good.
But 2.42% gives our citizen 61% higher income: almost twice as much.

That said, the real golden age of growth was from 1950-1973, based on worldwide data, as Angus Madison interprets it.

40

The fed seems to do everything backward, but it is with a purpose.
Which is to support the ultra rich of all nations, and the monopoly corporations they rule.
The fed does not service the US per se.