Editorial: Federal Reserve Not a Rational Actor

The Federal Reserve System raised the federal funds rate, which determines U.S. interest rates, from .5-.75% all the way to 2.25-2.50% following the inauguration of President Donald Trump. As we noted in our flagship editorial on monetary policy, these hikes sprouted from the Fed's over-reliance on Phillips curve, which led them to intentionally dampen economic growth. They did their job so well that it was to a fault:

Between the September 27, 2018 rate hike and the aftermath of the December 20, 2018 increase, the Dow Jones industrial average shed a total of 4,648 points.

Meanwhile, the yield on the 10-year U.S. Treasury bond plunged from 3.06% (September 27th) to 2.74% (December 24th) while the 1-month yield surged from 2.1% to 2.42%. The indication is that as the Fed continuously hiked their rates, investors became more and more frightened: The Treasury had to pay more to service short-term debt because creditors, unsure about short-term economic conditions, flocked to long-term havens for their wealth.

It is no surprise that investors responded to the rate increases the way they did. Credit, easily accessed, is an essential for a strong economy. It provides individuals and businesses the capital they need to purchase homes, build factories, develop new technologies, and perform all of the other activities that contribute to economic growth.

The Fed's policies, by restricting capital, would have tanked the gross domestic product had the markets overlooked their precariousness. While a 4,648-point plunge in the Dow Jones is never desirable, it was effective in December as it allowed Fed officials to see the light and give up on raising interest rates.

Now, after months of maintaining the 2.25 to 2.50% rate it set in December, the Fed is planning on going a step further: The Wall Street Journal notes the Fed "indicated [it] could respond to any economic deterioration by cutting interest rates" (emphasis ours).

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Consider the sequence of events thus far: Federal Reserve officials threw the markets into chaos because they sought to suppress economic growth. After realizing that their rate-hiking crusade, if taken any further, would lead to irrevocable economic damage, they slammed on the brakes. Now, they are going to cease and desist their rate-hiking efforts altogether, rendering useless thousands of man hours, countless cases of heart palpations among the investor class, and months of economic uncertainty.

While the players -- e.g. Chairman Jerome Powell, St. Louis President James Bullard, etc. -- are fresh to the scene, the scenario of the Fed acting foolishly, recklessly, and harmfully is hardly new.

In Capitalism and Freedom (1962), the late economist Milton Friedman observes that the Fed has been up to these antics for at least ninety years. Worse yet, their behavior greatly contributed to the Great Depression.

Dr. Milton Friedman

Dr. Friedman writes that even though the economy recovered partially in early 1931,

The tentative revival was ... short-lived. Renewed bank failures started another series of runs and again set in train a renewed decline in the stock of money. Again, the Reserve System stood idly by. ... [T]he books of the 'lender of last resort' showed a decline in the amount of credit it made available to its member banks.

Continuing, Dr. Friedman recounts the Federal Reserve's 1931 behavior with regards to the discount rate:

Although gold had been flowing into the United States in the prior two years, and the U.S. gold stock and the Federal Reserve gold reserve ratio were at an all time high, the Reserve System reacted vigorously and promptly to the external drain as it had not to the previous internal drain. It did so in a manner that was certain to intensity the internal financial difficulties. After more than two years of severe economic contraction, the System raised the discount rate--the rate of interest at which it stood ready to lend to member banks--more sharply than it has within so brief a period in its whole history before or since.

This history lesson from Dr. Friedman clearly demonstrates the Federal Reserve System's longstanding propensity for spurring economic malaise through technocratic means. In the contemporary case, described in length heretofore, the Fed is simply adding more counts of "bumbling foolishness" to its rap sheet.

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American elected officials have demonstrated a distributing lack of regard for the nation's monetary policy. Since the passage of the Federal Reserve Act of 1913, they have allowed an independent organization nominally run by political appointees to determine the trajectory of financial markets, the U.S. dollar, and the economy at large.

While we detest centralization, we would understand supporters of the Federal Reserve if the system had a halfway decent record. However, by any metric, it does not: The Fed plunged the economy into the depths of contraction in 1931, and it attempted to do the same thing months ago (amid an economic expansion!).

Insanity, according to the common refrain, is "doing the same thing over and over again and expecting a different result." If America continues to allow a squadron of unelected bureaucrats to manipulate the accessibility of credit, it will continue to see the same (poor) results.

That is insanity by any definition. Rein in the Federal Reserve.