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IPFS News Link • Federal Reserve

The Wrong Way and the Right Way To Fix the Fed

•, By Joseph T. Salerno

Today all governments and central banks operate under the ideology of inflationism. The underlying principle of inflationism is that the quantity and purchasing power of money determined by the free market leads to deflation, recession, and unemployment in the economy. The inflationist ideology is therefore embedded in the very concept of monetary policy, which can be defined as an increase in the supply of money aimed at lowering the purchasing power below the level determined by market forces. In other words, the purpose of monetary policy is perpetual inflation of money and prices.

For the past sixty years there has been a great debate about monetary policy. Some economists argue that monetary policy should be left to the discretion of expert central bankers who are free to adjust their decisions and actions to actual or anticipated changes in the economic situation. Their opponents argue that monetary policy should be dictated by a legislated rule that constrains the actions of the money printers.

Lately even some Austrian-oriented economists have adopted the position that, under a fiat-money system, legislated monetary policy rules are superior to bureaucratic discretion in providing the proper timing and expansion of the money supply. They argue that policy rules resolve the problems that plague central bankers trying to decide when and how much to expand the money supply, such as a lack of knowledge, distorted incentives, and inconsistency in their own preferences. But their arguments miss the point. It is not the formula or procedure for creating money but the very fact of doing so that inevitably drives up prices and distorts market outcomes.

Furthermore, all monetary policy rules are arbitrary and inefficient because they do not take account of market prices. Under the gold standard, the quantity, purchasing power, and distribution of money are determined not by the discretion of bureaucrats or by artificial rules but by what Mises called "inexorable economic law." On the free market, money production is carried out by entrepreneurs risking their own capital based on economic calculation using market prices. Unlike central bankers, their decisions in producing money are disciplined by the profit-and-loss mechanism, which tends to ensure that the supply of money is optimal at any point in time.