Why Fed Reform Could Be the Biggest Sleeper Issue of 2024

From The Daily Economy:

Joseph Sternberg, author of the “Political Economics” column at the Wall Street Journal, has been on the Federal Reserve’s case recently. He continues to take central bankers to task in his latest article. “The next president will inherit a Federal Reserve staffed by economists — and their intellectual helpmates in academia — who still don’t fully understand what has happened over the past few years, let alone over the past few decades,” Sternberg warns. He’s right. Fed officials admit to only limited and contingent culpability for high inflation in recent years.

The Fed is a flawed institution at best, and a failed institution at worst. Sternberg suggests several reforms. While potentially helpful, none go far enough.

First, Sternberg castigates the fashionable yet unfounded belief amongst policy economists that “Mr. Trump’s economic agenda of tariffs and tax cuts would be inflationary.” Sternberg is right to call out this nonsense.

Tariffs would make specific goods and services more expensive. This is a relative price effect. It only shows up in the general price level if it affects enough prices to drive up the index—and even then it doesn’t really qualify as inflation, because it’s a one-time transition to a higher price level. Inflation means a higher growth rate for the price level.

Tax cuts aren’t inflationary, either. If anything, by incentivizing additional savings and investment, tax cuts may result in a small productivity boost, and hence mild disinflation. The crude Keynesianism Sternberg calls out, despite its consistent record of failed predictions going back more than 70 years, is still alive and well amongst economists who see themselves as efficiency engineers first and social scientists second. We can safely ignore them.

Next, Sternberg laments Fed decision-makers’ “groupthink,” explained in part by the concentration of authority in the “Washington-based Board of Governors in thrall to the central bank’s research department.” The “Fed’s independence from the rest of the government” amplifies its irresponsibility. It “means politicians and voters can’t enforce accountability.” Sternberg correctly highlights the Fed’s adoption of flexible average inflation targeting (FAIT) in August 2020 as an example of deep institutional flaws. The Fed is picking its own goals and deciding whether or not it has achieved them. In other words, it’s a judge in its own cause. That’s unacceptable for anyone who cares about the rule of law.

How to fix this? Sternberg suggests changing how the Fed makes decisions, so that regional Fed branches have more input. He also wants Congress to keep a closer eye on monetary policymakers. These are probably good ideas. At the margin, they would help. But we can and should do more.

Here are a few harder-hitting ideas for Fed reform:

Get rid of the dual mandate. It’s redundant. The Fed’s monetary policy activities should solely focus on price stability.
Pare back the Fed’s regulatory powers radically. The Fed should ensure banks are adequately capitalized against short-term liabilities. That’s it.
End further credit allocation. Close the discount window.
Shrink the balance sheet. Return to a “Treasuries only” policy for open market operations.
Stop paying interest on reserves. Ditch the floor system and return to the corridor system.

For even more radical (and effective) reforms, consider the following, in ascending order of implausibility:

Compel the Fed to stabilize the dollar, or current-dollar GDP, or a related nominal anchor. If central bankers fail, they get fired.
Eliminate the FOMC. Automatically grow the monetary base by a set percentage each year. Long live Milton Friedman!
Freeze the monetary base. Outsource monetary policy to the market. From now on, financial intermediation (banking) is the sole means by which the money supply changes. The only requirement is banks must redeem their liabilities for fiat dollars, the stock of which is now fixed.
Revive commodity money. The gold standard is massively underrated. It’s not as attractive an option if the US is the only economy on gold. But it’s still worth a look.

“Fed reform could be the nerdiest sleeper issue of this campaign season,” Sternberg concludes.

I can only wish. Americans are hopping mad about dollar depreciation. But even with 9-percent consumer price inflation during 2022, Congress never seriously considered changing how the Fed works. Nevertheless, it should. I hope Sternberg is right about citizens’ appetite for reining in the central bank – the hungrier, and nerdier, the better.

From The Daily Economy:

The Fed is a flawed institution at best, and a failed institution at worst. Sternberg suggests several reforms. While potentially helpful, none go far enough.

Here are a few harder-hitting ideas for Fed reform:

Get rid of the dual mandate. It’s redundant. The Fed’s monetary policy activities should solely focus on price stability.
Pare back the Fed’s regulatory powers radically. The Fed should ensure banks are adequately capitalized against short-term liabilities. That’s it.
End further credit allocation. Close the discount window.
Shrink the balance sheet. Return to a “Treasuries only” policy for open market operations.
Stop paying interest on reserves. Ditch the floor system and return to the corridor system.

For even more radical (and effective) reforms, consider the following, in ascending order of implausibility:

Compel the Fed to stabilize the dollar, or current-dollar GDP, or a related nominal anchor. If central bankers fail, they get fired.
Eliminate the FOMC. Automatically grow the monetary base by a set percentage each year. Long live Milton Friedman!
Freeze the monetary base. Outsource monetary policy to the market. From now on, financial intermediation (banking) is the sole means by which the money supply changes. The only requirement is banks must redeem their liabilities for fiat dollars, the stock of which is now fixed.
Revive commodity money. The gold standard is massively underrated. It’s not as attractive an option if the US is the only economy on gold. But it’s still worth a look.

“Fed reform could be the nerdiest sleeper issue of this campaign season,” Sternberg concludes.

What we’ve seen since 2008 is nothing short of a theft of the commons. Except it happened in little pieces that seemed unrelated at the time. But if we look at the story holistically, it all comes together.

When we step back and view the entire picture, what emerges is not just a story of market excesses and economic shifts. What we see is the gutting of middle America – be it intentional or otherwise.

Now the question is – are we going to see the restoration of the American middle class in the coming years… or are we going to watch everything devolve into a modern redux of the War Between the States, more commonly but mistakenly known as the American Civil War?

Today’s Washington isn’t governed so much as stage-managed.

Politicians don’t solve problems; they perform them.

The current fixation is affordability — a word that will be repeated ad nauseam from now through the 2026 midterms, until it becomes as meaningless as “bipartisan.”

The script hasn’t changed in decades: promise relief, pass a law that raises costs, blame capitalism, hold hearings, fundraise, repeat.

Yes, Nvidia’s profits are up 500%, and its share price followed suit — a rare case where the story actually matches the math. But that’s the exception, not the rule.

Beneath the headlines, we’re starting to see the kind of financial gymnastics — circular lending, balance-sheet origami, and creative “partnerships” — that usually signal the boom is running out of breath.

If history rhymes, it looks like we’re closing in on the tail end of a mania.

As interest rates fell, investors swarmed into real estate, lured by yields and the illusion that home prices never fell. Wall Street’s private-label securitizers were soon packaging everything from pristine mortgages to what were effectively loans scribbled on napkins, thus turning them into bonds that glowed like gold — until you looked too closely.

For their part, the regulators and ratings agencies conveniently looked away and allowed the bubble to grow. Fannie Mae watched the frenzy from the sidelines at first.

The company’s mandate — written in law — was not to chase profits but to promote affordable housing. That is to say, to make sure that teachers, nurses, and other first-time buyers could own their own homes and unlock the American Dream.

But as Wall Street flooded the market with high-risk mortgage products, political pressure mounted. Congress demanded that Fannie “do its part” for low and moderate-income families.