Thursday, May 01, 2008

Should We Blame Congress, Rather than the Fed for High Gas and Grocery Prices?

A couple of days ago I posted criticisms of the Federal Reserve, specifically aiming barbs at Fed Chairman Ben Bernanke. The gist of my post was that the Fed’s record of irresponsibly lowering the short-term interest rate is the source of a significant portion of the inflation that is hitting Americans’ pocketbooks hard right now.

Congressman Paul Ryan (R-WI) says in this WSJ op-ed that Bernanke has been dealt a bad hand. The Fed, claims Ryan, is only doing its best to fulfill its congressionally mandated responsibility — a mandate that has two requirements that often directly oppose each other.

From its inception in 1913 until 1978, the Fed’s “principal role was to maintain a sound currency with stable prices.” But in its typical fashion of creating long-term problems by solving short-term issues, Congress passed the Humphrey-Hawkins Full Employment Act of 1978, which added to the Fed the responsibility to ensure “short-term economic growth.”

This explains the Fed’s schizophrenic behavior. Rep. Ryan says that “in its efforts to accomplish both” long-term price stability and short-term economic growth, “the Fed could end up satisfying neither.” While the Fed and Chairman Bernanke have earned scorn for Fed policies that have created a boom-bust cycle, the real culprit is Congress.

Rep. Ryan believes that the solution is to return the Fed to its pre-1978 single-purpose mandate of ensuring price stability. To that end, he says he has introduced the Price Stability Act of 2008. As of posting time, I cannot find a listing for this bill on Thomas. Ryan suggests that this bill should earn bipartisan support.

Such a bill might be welcome. But is it necessary? Economist Brian Wesbury asserts in this WSJ op-ed that our economy has been in the same position before, and that the solution is known. We simply need to do what Fed Chairman Paul Volcker did in 1980 when he “lifted the fed funds rate significantly above GDP growth and held it there long enough to end inflation.” Although this pushed up the interest rate temporarily, it “instigated a steep decline in oil prices, and drove a stake through the heart of stagflation.”

Presumably, Mr. Volcker was operating under the same 1978 law by which Mr. Bernanke is constrained today. Yet Volcker was somehow able to do what was necessary to tame the inflation monster. What was different back then from today? Are the people at the Fed today ignorant of 1980s financial and economic history? Were the people at the Fed in 1980 smarter than the people that are there today? I doubt that either of these things is true.

The most plausible explanation, it seems to me, is a lack of leadership — an unwillingness to take the heat from both Washington and Wall Street that would inevitably come from taking the unpopular but necessary steps to correct the economy. As the old saying goes, if you can’t take the heat ….

I would hope that Rep Ryan would be aware that our parallel economic woes of nearly two decades ago were resolved without additional legislation aimed at the Fed. Perhaps he is simply hoping to remove any excuse Bernanke and the Fed Governors might have for refusing to take the steps necessary to return us to price stability. But, since Bernanke’s term does not expire until Feb. 1, 2010 and since most Fed Governors seem to lack the fortitude to do what is needed, perhaps Ryan sees his legislation as the best way to get the job done.

Be careful. As stated above, Congress has a penchant for creating long-term problems in an effort to resolve near-term issues.


Jesse Harris said...

Given how long many members of Congress have been there, I'm sure they were present for that vote in '78. I know Orrin Hatch was.

y-intercept said...

Bernanke is in a horrible situation. Congress and the Bush administration have been pursuing inflationary spending policies with the idea the Fed could some how save the country from realizing the inflation of their spending.

The real problem with all of this is that the forces lined up against the free market will use the misbehavior of Congress in their claims that the free market failed.

Unfortunately, McCain gave the world zero reassurance that his adminstration would be any different when he proposed a gas tax vacation.

Scott Hinrichs said...

Jesse, it seems to me that short-term legislating benefits both short-timers and long-timers in Congress. Lots of these people will be out of office by the time the chickens come home to roost on any legislation they vote on. But the long-in-the-tooth guys that are still around can usually spin it into a political opportunity (and probably even a campaign war chest enhaning opportunity).

Scott Hinrichs said...

Kevin, discretionary federal spending has risen faster under Bush II than at any time in the history of our nation. The Bush II spending increases have even dwarfed the rise during Johnson's Great Society spending. No doubt that the executive branch should bear some of the blame for our economic woes, along with its willing accomplices in the legislative branch.

Rep. Ryan is correct when he says that Bernanke has been dealt a bad hand. But Wesbury is also correct when he says that Bernanke has the power to remedy a great deal of the inflation.