Federal Reserve Policy Misallocates Resources

The Federal Reserve – along with any other central bank that has a government-granted monopoly over money – does great damage to the economy.  It hurts production and lowers our standard of living.

Unfortunately, it gets away with this to a large degree because it is hard to trace.  Many people – some libertarians included – think the Fed’s primary damage is causing rising prices.  While this is one possible symptom of the Fed’s monetary inflation, it does not really pinpoint the damage that is being done.

Worse, when we are in an environment of low price inflation (according to government statistics) as we are now, many people assume that there isn’t damage being done.  The Keynesians will say that the Fed can keep interest rates low and even increase its balance sheet (through more money creation) because there is no immediate threat of price inflation.

But everything the Fed does is damaging to the economy.  Unless it is doing absolutely nothing, which is never the case, it is distorting the economy.  Whether it is manipulating interest rates or changing the money supply, it is distorting the price of money and how resources are allocated.

If the Fed weren’t centrally planning the economy, then we would likely have falling prices due to increased production and technology. But we don’t get this benefit because of the Fed.

The Fed also greatly misallocates savings and investment.  In most cases, the savings rate would likely be higher if we had a free market in money and interest rates.

The Fed also continues to redistribute wealth.  Again, it is unfortunate that most people cannot recognize this, although I think there is more of a sense of this happening, even if people can’t quite explain it.  The Fed is paying banks 0.25% on their reserves.  If the Fed raises its key interest rate, the banks will get paid more by the Fed.

Where does this money come from?  It comes from the Fed’s own balance sheet, which it built up by creating money out of thin air.

When the Fed increases the money supply, it is redistributing wealth, even if it does not result in price inflation.  Even if the newly created money goes into excess reserves at banks, it is still a redistribution of wealth and a misallocation of resources.  If nothing else, it is funding the government’s debt, and the government’s spending is a misallocation of resources.

While government regulation and taxes stifle the economy to a great degree, the Federal Reserve is really the worst culprit of all.  It enables the debt to grow over a long period of time.  It is more deceptive, as it takes away people’s money without them really knowing what happened.

In other words, don’t be fooled like the masses into thinking that the Fed isn’t doing much damage because consumer price inflation is low.  Some people probably never even think about this.

On the optimistic side, I believe many more people are aware of the harmful effects of central banking than at any other time in the Fed’s existence.  Let’s hope this trend continues.

Leave a Reply

Your email address will not be published. Required fields are marked *