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Keep the Pols From the Money Presses
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20554 |
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CURRENT ISSUES
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11 / 1992 |
2,253 Words |
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Daniel J. Mitchell
Daniel J. Mitchell is John M. Olin Senior Fellow in Political
Economy at the Heritage Foundation. |
Whenever the economy's performance falters, incumbent politicians and their cohorts almost without fail call upon the Federal Reserve Board to lower interest rates. Treasury Secretary Nicholas Brady, for instance, has been arguing for three years that the economy would be much stronger if the nation's central bank, better known as the Fed, adopted an "easy money" policy. Regardless of how politicians describe it, the message is clear: They want inflation.
Fortunately, the Fed is not under the direct control of politicians and thus can ignore efforts to manipulate monetary policy for short-term political purposes. Monetary policy today is far from perfect, but, thanks to the leadership of Fed Chairman Alan Greenspan, a return to the rising prices and high interest rates of the late 1970s appears unlikely.
Why is monetary policy so controversial? Some say politicians understand little about most issues and almost nothing about monetary policy. Politicians do not realize, for instance, that the Fed does not set interest rates. Nor do they understand, apparently, that creating too much money will cause prices to rise. And for all their worshiping at the shrine of lower interest rates, politicians do not seem to realize that rising prices will cause interest rates to rise since lenders include an inflation premium in the rates they charge. Given the abysmal level of knowledge among policymakers, calls for misguided policies should come as no surprise.
Others maintain that politicians are smarter than generally thought. They may know that an inflationary monetary policy is bad for the economy, but they have few incentives to do the right thing. Elected official worry most about being reelected, and they will gladly support policies that create the illusion of good economic performance in the short run (i.e., through November) even if the long-run effects are clearly negative. Other policymakers see the Fed as a convenient whipping boy that can be blamed for the economy's weakness, an especially valuable option for those politicians who vote for higher taxes, more spending, and increased regulation, and want to deflect the protests of angry constituents.
Sound monetary policy is crucial to the economy as it promotes price stability, reduces economic distortions, and allows individuals to make long-term plans. In effect, money is the oil that allows the economy's wheels to turn smoothly. If, on the other hand, monetary policy is inflationary or deflationary, money becomes a wrench in the economy's gears, interfering with economic
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