Marchand

The Good of the Federal Reserve

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The Fed serves beneficial to today's monetary climate because of its ability to quell inflation and reverse poor economic markets. The Fed has control over interest rates and the amount of money available for the market. It can buy and sell securities to help deflate or inflate the economy as it sees fit. On their website, the Federal Reserve sets out their goals for monetary policy. Accordingly, they are spelled out in the Federal Reserve Act, the act that originally gave them their power, which states that the board of governor's should seek to "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

The Fed feels that their job is to keep prices stable for as long as possible because this fosters higher saving rates and investment. When adverse supply shocks and other detrimental acts toward our economy occur, the Fed helps by restraining inflation pressures and attempt to keep unemployment low to prevent high inflation. The Fed must also decide whether to give in to defusing price pressures or "cushioning the loss of employment and output."

Though the Fed may be to blame for the events of the great depression, Volcker's policies to end the stagflation of the late 1970s by limiting money supply were excellent. He successfully abandoned interest rate targeting and used the Feds ability to limit the money supply to quell inflation. Though it did come at a price with a nasty recession in the early 1980s, inflation has been low ever since and his policies were considered a success. Because markets are cyclical and world events have the ability to affect markets so strongly, the Fed is in place to make swings in the economy less intense. Opposed to rapid expansion follower by rapid recession, the Fed makes it possible to keep these highs and lows in check to avoid larger problems. http://www.rpi.edu/web/Campus.News/photos/volcker.jpg

Kevin Dowd's Laissez-Faire Banking

Does Europe Need a Federal Reserve System?

Kevin Dowd discusses his ideas on how a Federal Reserve would affect Europe. Please note that his book was written in 1993 prior to the creation of the European Central bank in 1999, yet his ideas are still very relevant in comparing a country with a Fed as opposed to a group of countries without.

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In April of 1989, the European Community (EC) received a report from Jacques Delores on the most appropriate direction towards economic and monetary union. The result was basically a European Federal Reserve in which national banks would merge together to form a European bank and currency. Dowd feels this may not be beneficial and analyzes the process through a cost-benefit analysis.

Dowd feels the main benefit of a common currency is ridding the market of currency exchange costs. Therefore, international trade would be easier as a result of a single currency because firms would not have to factor in or worry about fluctuations in different exchange rates. Also, to determine if this would be the most beneficial method, Dowd feels that a free competition between the currencies could exist to determine what would happen. He states "if the public felt fixing the rates was worthwhile..(it would) peg the currencies, if (they) wanted a single currency as well, one would evolve from the competitive process."

Price Stability, Inflation, and Other Issues

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Dowd presents another issue discussing price stability. He criticizes the Delors report because, though it states the European Central Banks mission is "that the bank is expected to achieve price stability, there is no evidence on how this may occur. He feels that because other national banks have failed in continuing price stability, there is no reason to believe the European banks will have much more success. Like the Federal Reserve, the Delors report feels that the ECB should be watched and held accountable by the European Parliament. Dowd feels that this would deter the independence of the bank and make it more difficult for the bank to pursue policies with stiff objection from politicians.

Because of inflations impact on employment and vice versa, Dowd disagrees with the ideas that a central bank can control inflation. Because the ECB would be less than an independent entity and the government would have the ability in persuasion, inflation rates may stagger as politicians pressure for higher inflation. According to Dowd, this will give the institution less credibility with the private sector, leading to more uncertainty and even higher inflation.

In 1983, the EC was literally bankrupt as a result of excessive spending. This financial crisis led the EC, through the Brussels summit, to tighten spending. Dowd criticizes the Brussels summit because he felt there was no way to penalize or prevent the EC from continuing on its spending policy. Instead, the community was given resources to quiet the crisis even though it would still exist.

Alternatives to a central bank

Maintaining the European Monetary System(EMS) is a superior alternative to Dowd. With this system, member nations agree to keep their currency exchange rates close together. For a country to then pursue an expansionary policy, it would have to run down its foreign exchange reserves or borrow. According to Dowd, as the conservative banks continue to collect currencies that are being run down, the expansionary banks will continue to lend but eventually run out of money and no longer be able to keep a solid exchange rate. This leaves the conservative banks in charge because of their excessive reserves and allows them to determine the flows of monetary growth.