04 September 2012

Federal Reserve

With a bunch of “End The Fed” crackpottery floating around, I'm long overdue to assemble some materials about the Federal Reserve. Here are some links:

  • Propaganda from the Fed: History, an overview, and an approachable explanation of the functioning of the Fed. Obviously these merit a skeptical eye, but many anti-Fed activists seem not to have even heard this stuff.
  • Debunking major myths about the Fed at PublicEye.org
  • The Austrian school of economics, which blames central banks like the Fed for the business cycle, takes a beating at RationalWiki.
  • Commentary in the context of Occupy from lefty Wall Street watcher Doug Henwood, who also has a good description of the case against the gold standard.
  • Plutocrats and Printing Presses is a Paul Krugman post explaining how expansionary monetary policy by the Federal Reserve is not a trick to build the wealth of Evil Rich Bankers, as many anti-Fed crackpots claim.
  • The Crash of 1907, which inspired the creation of the Federal Reserve, described in detail.

Update

I recently stumbled across a blog post which actually provides about as good an explanation in 250 words of why Keynesian stimulus is supposed to work.

Let's say there are 8 million healthy, unemployed people in US.

The Treasury can simply print 4 million pieces of IOU claiming that the holder of this piece of paper is entitled to a free massage or a free cleaning services or free haircut or free baby-sitting or free moving (basically any service worth $50 with negligible raw material) from another unemployed person and simply distribute it to unemployed people.

What happens? On Day 1, the 4 million who got the coupons tender their coupons and receive services (increase in daily GDP 4 million * 50 = 200 Million).

On Day 2, the opposite happens and this goes on quite a while. Now, lets say the economy improves and 2 Million get employed. Now essentially we have 1 Million extra coupons (inflation). Treasury will tax the lucky/rich people who have a job and a coupon and essentially retire them.

Or, let's say the economy deteriorates and 2 more more million get unemployed. Now there are few coupons and some may be willing to do the job for 3/4th of a coupon (deflation). Now essentially Treasury can print extra 1 million and distribute them.

Notes:

  1. We need flexible money supply.
  2. Having gold standard is stupid. What does amount of gold supply have to do with anything?
  3. We increased GDP by simply printing pieces of paper.
Bonus:

Let's say someone comes with a brilliant idea that one unemployed can actually perform two jobs a day. Now instantly the capacity doubled and Treasury can print double the amount of IOUs.

The host of this post is actually a libertarian skeptic of Keynesianism, quoting a commenter; his argument against this is nuh-uh, that's absurd! Really; go look if you doubt me.

I haven't looked closely at any of the other discussion on that blog, but I scent Austrianism since there's the explicit allusion to gold. Austrian economics holds that one must abolish the Federal Reserve and return to a gold standard in order to banish the boom-and-bust cycle of the economy. This is the school favored, most famously, by Ron Paul, but the father of this school is Ludwig von Mises.

Because of some discussion on Facebook I am reminded of a long blog post from Brad DeLong trying to puzzle out how von Mises' theory works.

I find myself under a mysterious but inexorable and irresistible compulsion to waste what would otherwise be productive work time trying to make some kind of sense of it--to at least understand wherein lies the error, and how somebody trying very hard to understand the economy (never mind that he is a big fan of the political leadership of Benito Mussolini) can go so pathetically wrong.

The crack about Mussolini references von Mises' praise of Mussolini, which is troubling but not necessarily a proof that von Mises' economics is wrong.

Unhappily, DeLong fails to find a clear theory that he can find wrong. He proposes several possible descriptions of von Mises' thinking, but all of them founder on the rocks of things that von Mises said. “Not right, and not even wrong.”

Needless to say, there is no coherent model of a monetary economy in which this could possibly be correct.

Thus I interpret it as the survival at a prelogical level of a deep attachment to a cost-of-production theory of value, whereby it is the sin of the Mammon of Unrighteousness for anything that can be produced as cheaply as fiat money is to actually have value, and that sin must bring fearful retribution from the Gods of the Market.

The post attempts (mostly) to be clear to folks with a decent lay understanding of economics, but if you're coming from a cold start it may be tough sledding ... though some Google should make it possible to follow.

There is one reference that I'll Google for you in advance: the babysitting coöp. It's another famous short example of the logic of Keynesian stimulus that Paul Krugman is fond of alluding to. He has a short version of the babysitting coöp story at Slate. I found it very clarifying when I first encountered it; I'd encourage you to click through to it before taking on DeLong's lengthy post.

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