I am like you, always wondering what is the Federal Reserve going to do next? And my next guest knows a little bit about that.
He happens to be.
An economics professor at Texas Tech University's Business School and a researcher at Texas Texas free Market Institute. It's refreshing to know that Texas Tech has a free market Institute, first of all, So how long has that been around and how long have you been a part of it?
That's really exciting to be a part of the Free Market Institute. We've been around for more than ten years now. Is officially kicked off in twenty thirteen with full operations beginning and a twenty fourteen and we're dedicated to the study of the free enterprise or capitalist system. We of course all have our preferences for what kind of economic system we'd like to live under, but we are first and foremost a scholarly research institute, and it's been just an intellectual treat to be here.
So I could ask a follow up question about those other forms of isms that people would like to live under, but I want to stay focused here on what we're talking about, and that is a Federal Reserve, And on the face of it, to me, the Federal Reserve seems like an institution that is by its very design anti free market.
Am I right or wrong?
It depends on what you compare the next best alternative to. So if you think that we should have a completely free market and money in banking and finance, a position that I actually subscribed to, then yes, the existence of a central bank is a move towards a more status economic arrangement for governing the supply of money and credit.
I myself am much more of a fan of what economists call the classical gold standard, the system that prevails from roughly eighteen seventy nine up until the start of the First World War in the United States. Some economists disagreed. I think that system didn't work very well. I think it was too unstable, and so they're happy that that is here. I think they're misreading the historical data. When I look at economic growth, when I look at prices,
I see some pretty good stuff. In the late nineteenth century that was an economic cornucopia that we would do well to try and recreate.
So when we're talking about the Federal Reserve, first of all, I want to do a little bit of a history lesson.
And I just told Alex this off the air.
I know everybody in this listening audience knows the Federal Reserve is incredibly important because they set interest rates, and interest rates determined mortgage rates and car loan rates and business loan rates and all of that stuff. But I think a lot of people don't understand how the Federal
Reserve even came into being. So we can do a little bit of the Creature from Jekyl Island, which is a phenomenal book written about the formation of the Federal Reserve that most people look at the number of pages and go a hard pass. I'm not going to read it. But why do we have this system in the first place.
We have the system in the first place because in the early twentieth century there was a growing consensus among legislators, policymakers, business executives, bankers, financiers, but the monetary system of the United States just wasn't working. It was very fragile, and that perception was true. The US system was needlessly crisis throne, and that was a matter of design, and the US system was actually design to be fragile. For various reasons,
they go to satisfying political constituencies. And so finally the moment for reform came about, and the question was going to be are we going to embrace a more free market system for money in banking and finance, a system that in the early twentieth century countries like Canada or Great Britain had, or is it going to be the case that we're going to embrace a more top down,
hierarchical arrangement for the governance of money and credit. And I don't think that everyone who was responsible for the creation of the Federal Reserve realized that they're picking option two. At the time, they probably thought that they were just shoring up the weaknesses in the US banking system. But they created this new institution that ultimately would grow to
have major powers over money, credit, and interest rates. And that was ultimately a move from a decentralized, market based arrangement for money and banking.
So there is I saw something today which was kind of unusual where the Fed Chairman said something along the lines of that the government needed to get it spending in check. And reason why that was noteworthy is because the Federal Reserve is supposed to be non political. I personally don't believe any organization could be truly non political, because whoever is working in that organization is going to bring their their own biases with them when they come
to work. But how has the FED maintained that sort of separate status.
Have they done a good enough job?
It's the difficult balancing act, especially when you consider that the Federal Reserve does not, have, as the financial press frequently says, a dual mandate. They have a triple mandate. You always hear that the FED has two jobs given to it by Congress maintain maintain full employment and stable prices. But if you actually go to the Statute to the law which authorizes what the FED is supposed to do, there's a third point to that mandate, which is maintain
moderate long run interest rates. And so that's what I think the Federal Reserve is trying to do. When as top officials start to warrant about the US fiscal trajectory, they realize that if our debt and deficit path is un sustainable, that's going to mean interest rates are going to rise pas the point where they can be reasonably called moderate. And so, while I understand that people are
worried about the Federal Reserve meddling in fiscal politics. That seems like a step into the partisan arena that we don't want our central bankers to make. The fact of the matter is the law of the land requires them to care about interest rates. And if we don't want that, we should change the law, something that I add, I would be very much supportive of. We should change the law.
So what would you see the preferred law in this case?
You want to narrow the mandate of the Fed.
Right absolutely, price stability. Only. The only thing the Federal Reserve can reasonably control in the long run is the dollars purchasing power. Giving yet responsibility for promoting employment, for promoting moderate long run interest rates, messing with labor markets, with capital markets, that's just the recipe for money mischief. Over it's more than one hundred year history, the Federal Reserve has quite frankly, gotten a lot more wrong than
has gotten right. And so I would like to see the Central Bank forced by Congress that it ultimately answer to focus on the one thing that we know that monetary policy can really control, which is the general purchasing power of the dollar. Give the Fed a much more narrow mandate, focus it on a more attainable goal, and let's put aside all this other stuff that the FED, quite frankly, has proven not very good at. I think that that would be the best that we can do at this point.
I found it a little bit outrageous that the FED was sort of, you know, taking the government to task, although I agree with the entire concept. Right, it wasn't wrong to say the government needed to bring spending under control, But it was the FED that printed a whole bunch of money that allowed the government to keep spending and spending at absorbit at rates. So it's almost like, wait a minute, aren't you part of the problem here.
That's right. The Federal Reserve did intervene in the aftermath of the COVID economic crisis to stabilize the market for government debt by doing what by ensuring that treasury rates didn't rise too much, making sure that Uncle Stam could still borrow and spend. The perception was at the time that they needed the capacity to meet the emergency, and the Central Bank was going to help them do that. But you're absolutely correct that came with a flood of
new money. We're talking trillions and trillions of dollars of new liquidity, and the eventual consequence of that was predictable to anybody who's read as Milton Friedman inflation. We still haven't gotten to the point where price growth has moderated back to what we like to see historically. Usually the FED wants to see about two percent annual inflation. We're still hovering somewhere between two and a half and three.
That might not seem like a lot, but it means that prices over the long haul are rising much faster, and that's something that ordinary Americans are understandably frustrated about.
It would be, you know, one thing, to say that if prices go up and incomes go up to then it would balance out.
But we're not seeing that yet.
Here's my question about the decision makers at the FED to your point, obviously they had never read anything about how periods of inflation are always preceded by periods of printing.
Too much money.
And why is it that we seem to only have one kind of economists in the Fed making decisions that seem to do things like allow government to get bigger. Where are the where are the Austrian economists in the Federal Reserve.
Do we have any balance?
That's a great question. Two great questions. Actually. The first part, I think comes from the fact that about a generation ago, twenty ish years ago, monetary economists became disenchanted with using the money supply to gauge the stance of monetary policy. And on the surface, it sort of seems like they had a case. The rate of money growth really stopped predicting the rate of price growth as well as it had in the twenty thirty forty years prior due to
financial innovations in the banking sector. But really, if you use the right measure of the money supply, if you use broader, more liquid measures of the money supply, the relationship between money on the one hand, and prices in general on the other hand, are pretty stable. So I would actually say that economists needlessly moved on from an older consensus that was more right than it was wrong.
The question of why don't you get any more restrained people at the FED, I think that there's a selection effect. The Federal Reserve actually has an outsized influence in hiring PhD macroeconomists and monetary economists. Many people who work at the Fed or gatekeepers at scholarly journals. People who are professors and the academy also sometimes have joint appointments at
the FED. And so this gives rise to a system where the only people who really go into monetary economics and macroeconomics are already predisposed to liking the FED, to liking central banking, and to want the institution to grow in importance. I don't think it's anything so crass as the FED paying them off or anything. I think that
they're actually true believers. But the selection effect is such that young, upwardly mobile economists only go into study monetary economics, only write their PhDs on monetary topics if they already think the FED is the greatest things on slice bread and they want to continue to support it. And so that's sort of how you get this arrangement where everybody who's into central banking is pros banking. So I don't think it reflects a true consensus, it's more a selection effect.
Would it be fair to say that someone who was more open to free markets in the Austrian school of economics will probably be happier in the private sector as well.
You have a lot more people who are sympathetic to Austrian economics, a lot more people that are sympathetic to Chicago style macroeconomics, the kind of economics that built in Friedman, who popularize the link between the money supply and inflation. That kind of economics again tends to not get a seat at the table when big decisions are made by
central bankers. Who are the people who really want to be central bankers, people who think that we need an activist, top down control of the economy using the levers of policy that Congress has granted the Federal Reserve, or at least has not punished the Federal Reserve for using. And so in that sort of a framework, you're just not going to get the free market restraining type people at
the table to offer their opinions. You get some smattering of hawks and doves, and it's nice that we have some inflation hawks on the Federal Reserve Board of Governor is the Federal Open Market Committee, But really that's not
that big of an intellectual range. Would you consider all the things that are important for understanding how monetary policy works to affect the economy, I, for one, would like to see a much broader view range of views represented, but it's not clear that we can get that given how the FED is currently constituted.
So if you could, let's just say Alexander Salter gets to take over the Federal Reserve today.
We wave a magic one.
What actions would you like to see the FED take to finally bring that inflation back down to that two percent target rate.
The great Austrian economist ludaigua and Nisus was once asked how he would reform the economic policy of Austria if you were a made king for a day. He said, if I were made king for a day, the first thing that I would do is advocate. So maybe I should say the first thing that I would do is resign. But assuming that I'm not going to resign, assuming that I don't have that option, I would focus much less on targeting interest rates and focusing on these intermediate things.
I think that we need deep fundamental reforms. The Federal Reserve should, as a matter of policy outcomes, target the growth rate of the price level and inflation index, or my preferred alternative, which is something that economists call nominal income targeting, basically stabilizing total dollar spending in the economy. It sounds complicated, But it's actually much more modest than
what the FED tries to do right now. Right now, they're always trying to get just the right interest rate target, just the right balance between capital supplying capital demand that gets interest rates exactly where they want them. We're giving this thing called forward guidance, where we're trying to convince markets about what interest rates are going to be next quarter or a year from now. Think about how complicated
global capital markets are. There's really no way that we can convey that information credibly, and so I just don't think that we should be trying. The most that the FED can do is ensure that the demand side of the economy is stable, and actually I think that we can do that by intervening much less. We don't need to intervene more, we need to intervene less, just credibly commit to saying, Look, the sole focus of our policy is going to be keeping the dollars purchasing power on
this path. Tell them what the path is, tell us what index you're targeting, and then hit it and then break for the day. We really don't need the Federal Reserve doing anything more than that, as far as its monetary policy powers are concerned. I think that financial journalists and economists have made central banking much more complicated than it needs to be.
So what mechanism specifically would you use to make those things happen? I mean, we're all trained, right, Society is trained that when you hear Federal reserve, your interest rates right after. So if they're kind of overshooting using interest rates or focusing like a laser on that, what other mechanisms are available to achieve that sort of demand side stability.
The most obvious one is the money supply itself. Again, economists are skeptical of that because the narrow measures of the money supply don't tend to predict inflation very well, but the broader ones still do, and I think that that relationship still does hold. Again, the conceptual way that this works is still I think the world that we're living in, right, you print up more money, you're going
to get prices everywhere going up. And so what the Fed should be doing is trying to keep the money supply growing to meet increases in money demand that come from one normal increases in population population growth, and two increases in real economic activity as the economy actually churns out more cars and suit jackets and laptops and houses.
The money supply should keep up with that to facilitate those additional transactions, So that could be one intermediate measure the FED actually starts to pay more attention to something that the vulgar FED did pay attention to for a while back in the nineteen eighties that I would actually credit it with ending the Great inflation. So I think that this is something that has a proven track record. It's much more modest than what the FED is trying to do right now, but I think that we could
use some modesty and some humility in central banking. Of course, we would need to have an entirely separate conversation when it comes to the FEDS regulatory oversight duties over the financial system when it comes to fighting financial panics and stemming bank failures. Even there, I think that they're trying to do too much, which is why it's not working
so well. In general, with these things, monetary policy and financial regulation are pretty blunt instruments, and so we should try and pursue broad based goals and simply not try and find tune things too much because it's just not going to work.
It's my understanding, and I could be wrong, because God knows, we've passed new regulations since I learned the statistic. But the financial services in banking industry is the most highly regulated industry around. I mean, so, are you talking about not deregulation but maybe streamlining processes or moving that investigative arm away from the FED?
I would like to send to focus solely on ensuring banks that are subject to its regulations maintain adequate capital against short run liabilities. Just make sure banks have a basic buffer stock right, make sure that they have enough capital on hand to meet extraordinary events. Beyond that, let markets do their thing. When you get more complicated than that one you try and dictate to banks the quality
of capital. When you have all these complicated formulas that try and weight capital by perceived safety, well, that presumes that regulators are really good at distinguishing safe assets for safe assets from risky assets. Who remembers two thousand and eight, to set all those subprime mortgage assets that went belly up, We're triple a safe according to the regulators and credit rating agencies. So it's not clear to me the regulators have got this at all.
That's another conversation though about those ratings agencies and how they absolutely failed spectacularly, maybe on purpose, maybe on accident in two thousand and eight, So it's kind of like who do you trust?
At that point?
I got a text message that said, Mandy, what did your guests think about going on the gold standard? That from Jim.
Great question. I really like the gold standard historically. I think it was a mistake getting off it. Just because something was great one hundred years ago doesn't mean that it's feasible to return to it today. I'm not sure what a path back to the gold standard actually looks like. And sometimes you might think it's pretty simple, right The United States government owns so much gold, there are so many dollars outstanding, Divide one by the other. That's your
new gold exchange rate, and boom, you're done. The problem with that is that the global financial system is really set up for the US to constantly export dollars in export US treasury debt, because that's the global reserve currency and the global reserve asset dollars in US Treasury debt, respectively. And the faster the developing world grows, the more safe US assets they demand. If you pull the rug out from that demand process by restricting the money supply and
treasury supply to whatever's going on in gold markets. I worry that the short run effect might be so shocking that it would actually erode whatever good a stable monetary system could deliver. I could be wrong about that, maybe to your pessimistic But the way that I approach these questions is show me what the plan is right to actually return to a commodity system or even a bitcoin system.
Who cares what the underlying commodity is. Show me the plan, and then we can discuss the cost and benefits of it. Because I have a hard time thinking about whether these things are worth doing in the abstract.
Doctor Alexander Salter.
He's an economics professor from Texas Tech University's Business School, also a researcher at Texas Tech's pre Market Institute. Fascinating conversation. I'd love to have you back on in the near future to continue more nerd conversation about the Federal Reserve and everything else. Thank you so much, alex for your time today.
Absolutely MANDI, you have a good one, all
Right, you two that is Alexander Salter