The Mixed Track Record of the Fed’s First 100 Years

While established as a lender of last resort, the Federal Reserve has morphed into a central bank with discretionary authority and a record of mixed results, according to Jerry L. Jordan, former President of the Federal Reserve Bank of Cleveland.

Jordan identifies a number of problems with the concept of central banking in general, including:

– Moral hazard: Central banks with discretionary authority create moral hazards, because the safety net offered by a central bank leads private financial institutions to act in ways that they would otherwise not act, because gains are privatized but losses are socialized.
– Myth of independence: Far from being independent, central banks feel political pressures and will try to alter policies in order to respond to crises. When central banks attempt to correct other government mistakes, there is no exit strategy that does not create other damage.
– Discipline: U.S. policymakers have not been disciplined by institutional arrangements intended to keep currency stable. In the 1960s, the U.S. began abusing its ability to borrow in its own currency, and the government ran larger and larger budget deficits.
– Transparency: Because the central bank’s future policy plans influence short-term behavior by the market, their deliberations must be conducted in secret. Debates over the Fed’s response to events cannot be broadcast in front of the public.

Today, there are essentially no rules governing central bank lending, explains Jordan. The Fed has loaned money to insolvent institutions, and there is no clear guidance governing who will, or will not, be bailed out in the future. Under the Fed, the U.S. has seen the Great Depression, 1970s-era inflation and a number of bubbles, panics and crises. We need effective arrangements, Jordan writes, in order to prevent more of the same from happening in the future.

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