Question. Professor Kimball - Former student here. Question. With QE3 recently announced, conversation about monetary policy and the Federal Reserve is picking up once again. I just got done watching one of those Institute for Humane Studies LearnLiberty videos explaining why we should end the Fed. It seems like most mainstream economists don’t take this view. Could you tell us your thoughts?
Answer. It is good to have a stable track of prices and output at its natural level. The Fed’s adjustments of the money supply make that possible. Without the Fed we would be at the mercy of other monetary winds—which could be anything from gold supply and demand to the vagaries of free banking. We would be particularly vulnerable to financial crises like the one we suffered in 2008. Without the Fed’s decisive action, the Great Recession would have been much worse. David Wessel’s book “In Fed We Trust: Ben Bernanke’s War on the Great Panic” is a good account. Unfortunately, that decisive action had to include bailing out big banks, which is a big part of why the Fed is unpopular now.
Economists have emphasized for some time now how important it is to have an independent central bank such as the Fed when inflation is too high to be able in order to be able to do the unpopular things necessary to bring inflation down. In the last few years, we have seen how important it is to have an independent central bank such as the Fed when inflation is too low in order to be able to do the unpopular things (such as bank bailouts and quantitative easing) necessary to bring inflation up—and in particular to avoid getting too close to negative territory. The Fed doesn’t always make the right decisions, but in general it is responsive to good economics in a way that other institutions often are not.