Generally, I agree with his discussion of the Fed, found below, which is excerpted from his essay The Economics of Innocent Fraud: Truth For our Time. Based on the Fed's actions today, I do think JKG's observations are worthy of a codicil, which is that, while the Fed has little consequence on the real economy, it can be quite effective in enriching the banks at the expense of savers. The Fed's zero interest rate policy and quantitative easing "lite" (soon to be QE2) are harming real Americans and need to stop.
THE ELEGANT ESCAPE FROM REALITYCOME NOW to our most prestigious form of fraud, our most elegant escape from reality. As sufficiently noted, the modern economic system is unpredictable in its movement from good times to bad and then eventually from bad to good. Boom, bubble and inflation go on to declining production, rising unemployment, reduced earnings, stable but lower prices. Then, in time, to a revival -to higher employment, greater earnings, talk if not the reality of inflation. To limit unemployment and recession in the United States and the risk of inflation, the remedial entity is the Federal Reserve System, the central bank. For many years (with more to come) this has been under the direction from Washington of a greatly respected chairman, Mr. Alan Greenspan. The institution and its leader are the ordained answer to both boom and inflation and recession or depression with its lower production, financial and economic contraction, distress and reduced employment. Quiet measures enforced by the Federal Reserve are thought to be the best approved, best accepted of economic actions. They are also manifestly ineffective. They do not accomplish what they are presumed to accomplish. Recession and unemployment or boom and inflation continue. Here is our most cherished and, on examination, most evident form of fraud.The false and favorable reputation of the Federal Reserve has a strong foundation: There is the power and prestige of banks and bankers and the magic accorded to money. These stand behind and support the Federal Reserve and its member- that is, belonging-banks. If in recession the interest rate is lowered by the central bank, the member banks are counted on to pass the lower rate along to their customers, thus encouraging them to borrow. Producers will then produce goods and services, buy the plant and machinery they can now afford and from which they can now make money, and consumption paid for by cheaper loans will expand. The economy will respond, the recession will end. If then there is a boom and threat of inflation, a higher cost of borrowing initiated also by the Federal Reserve and imposed on its lending to member banks will raise interest rates. This will restrain business investment and consumer borrowing, counter the excess of optimism, level off prices and thus insure against inflation.The difficulty is that this highly plausible, wholly agreeable process exists only in well-established economic belief and not in real life. The belief depends on the seemingly persuasive theory and on neither reality nor practical experience. Business firms borrow when they can make money and not because interest rates are low. As this is written, in 2003, during a recession, the lending rate of the Federal Reserve has been reduced roughly a dozen times in the recent past. These reductions have been strongly approved as the wise and effective response to the recession, so acknowledged in both popular and learned comment. How good this simple, painless design, free from politics and in the hands of responsible and respected professional and public figures free from political taint. No disagreeable debate, no pointless controversy. Also, and uncelebrated, no economic effect.Especially as regards recession, hope always awaits the next Federal Reserve meeting. There is then promise, prediction and ultimately no result. On no economic matter does history more reliably repeat itself. One should, however, be gentle. The action is reputable and well regulated; there is general agreement by the participants and approval from the financial world; it is just that nothing perceptible occurs. Recovery comes, but not in any visible way, from Federal Reserve action. Housing improves as mortgage rates decline. Elsewhere there is painful indifference. Interest rates are a detail when sales are bad. Firms do not borrow and expand output that cannot be sold.SINCE 1913, when the Federal Reserve came fully into existence, it has had a record against inflation and notably against recession of deep and unrelieved inconsequence. In World War I, prices doubled in the course of the two years the United States was at war. No remedy came from the new and magical central bank. In the 1920s, in Florida and then disastrously on Wall Street, came unbridled and, in its aftermath, deeply damaging speculation. There was no effective restraint from the Federal Reserve. Then for a decade the Great Depression, and once more no curative action from Washington and the Fed. Informed debate, no result. Deflation and depression persisted.During World War II, because of the previous wartime experience, inflation was greatly feared. In the event, however, it was closely controlled and no seriously unpleasant memory remains. Historians pass the problem by. This agreeable outcome was more than slightly because, acting on what had earlier occurred, there was no reliance on the Federal Reserve. Economic policy in this truly difficult time could not be based on hope or mythology. As one principally responsible for limiting inflation in those years (I was the deputy administrator in charge of price policy in the Office of Price Administration and thus immediately concerned with the action against inflation), I shared the belief that the Federal Reserve was irrelevant. So it was.In the decades since World War II, there have been lesser threats of inflation and recession. The Federal Reserve, after learned and intense discussion, has acted. There have been well-voiced approval, optimistic prediction and no effect.Such are Chairman Greenspan's public skills, such is the ingrained faith in any action involving money, that the Fed, as affectionately it is called, will receive credit if and when there is full recovery. The fact will remain: When times are good, higher interest rates do not slow business investment. They do not much matter; the larger prospect for profit is what counts. And in recession or depression, the controlling factor is the poor earnings prospect. At the lower interest rates, housing mortgages are refinanced; the total amount of money so released to debtors is relatively small and some may be saved. Widespread economic effect is absent or insignificant.In restraining inflation, or what seems such purpose, the Federal Reserve must be especially cautious; it cannot he thought to be in conflict with economic well-being. If and when recession returns, the defining forces, as later noted, will be the consumer spending and industry investment so called forth. On these, what follows from central-bank action is minimal. Business firms respond to diminishing sales. Here the Federal Reserve has no decisive role. Only in innocence does it control general consumer and business spending.Nonetheless, it is thought good to have an uncontroversial, politically neutral institution headed as in all recent times by an informed, confident and respected figure of no slight theatrical talent. How agreeable decisions taken in reputable surroundings beneath the portraits of the financially celebrated of the past. It is thus that economic policy should be decided. That nothing important results is overlooked. The belief that anything as complex, as diverse and by its nature personally as important as money can be guided by well-discussed but painless decisions emanating from a pleasant, unobtrusive building in the nation's capital belongs not to the real world but to that of hope and imagination. Here our most implausible and most cherished escape from reality. No one should deny those participating their innocently acquired prestige, their sense of personal competence, their largely innocent enjoyment of what in economic effect is a well-established fraud. Perhaps we should let their ineffective role be accepted and forgiven.
