Remember when Ben Bernanke was a fan of a more transparent Fed, with bright lines on where inflation should be and how to get there?

“Inflation-targeting countries have achieved lower inflation rates and lower inflation expectation,” he wrote in his 1999 book Inflation Targeting: Lessons from the International Experience. “There is also evidence that the use of inflation targeting increases public understanding of monetary policy, improves policy-maker accountability, and provides a discipline-enhancing ‘nominal anchor’ for monetary policy.” In 2003 Bernanke said targeting in the 2% range seemed “the optimal long-run average inflation rate” for the U.S.

But since taking office, you’ll hear no such comments from the chairman. The reason? Reality. While the European Central bank’s primary concern is controlling inflation, the American Federal Reserve has the dual responsibility of maintaining both price stability and employment, making Bernanke’s job a tough one.

No one ever seems to look at those goals and ask why price stability is important and how exactly does what the Federal Reserve do which effects employment.

The supposed need for price stability is a result of government interventionism. Mises says on page 219 of Human Action:

Shortcomings in the governments’ handling of monetary matters and the disastrous consequences of policies aimed at lowering the rate of interest and at encouraging business activities through credit expansion gave birth to the ideas which finally generated the slogan “stabilization.”

and after describes just how ridiculous the true idea of stability is:

Stability, the establishment of which the program of stabilization aims at, is an empty and contradictory notion. The urge toward action, i.e., improvement of the conditions of life, is inborn in man. Man himself changes from moment to moment and his valuations, volitions, and acts change with him. In the realm of action there is nothing perpetual but change. There is no fixed point in this ceaseless fluctuation other than the eternal aprioristic categories of action. It is vain to sever valuation and action from man’s unsteadiness and the changeability of his conduct and to argue as if there were in the universe eternal values independent of human value judgments and suitable to serve as a yardstick for the appraisal of real action[2].

The Fateful Wish for Price Stability is a nice writeup on Mises position.

And how does the Federal Reserve influence employment levels? It creates the illusion of prosperity. The Phillips curve is a joke. In the long run the correlation disappears. Mises covered this topic in Economic Freedom and Interventionism where in part he says:

It is not the operation of the market economy that generates unemployment with all its moral and material evils, but precisely the ill-contrived, although well-intentioned, actions of unions and governments. There is no other means to do away with unemployment than to abstain from any government and union meddling with the height of wage rates.

Inflation Not Fit to Fight Unemployment

The self-styled American “liberals” propose to do away with unemployment by inflation. They suggest an increase in the quantity of money in circulation through credit expansion.

Lord Keynes did not invent, but merely popularized this makeshift. He was well aware of the fact that inflation inevitably results in a rise in all commodity prices or, what is merely another way of describing the same effect, in a drop in the monetary unit’s, the dollar’s, purchasing power. But he argued that the wage earners will acquiesce in “a gradual and automatic lowering of real wages as a result of rising prices.”[1] It is obvious that Keynes thus fully admitted that nothing but a lowering of real wage rates can do away with unemployment. The inflation which he recommended was designed as a clever trick to cheat the workers. He expected that they would not be shrewd enough to realize that real wages had dropped and that, therefore, they would not ask for higher pay to compensate for the reduction in the monetary unit’s purchasing power.

He criticizes the practice further in the 1933 The Causes Of The Economic Crisis: An Address

Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later it must become apparent that this economic situation is built on sand.

The wealth creation is fiction. People become unemployed because employers believe they have more wealth therefore attempt to expand by hiring while those looking for employment unknowingly accept lower wages.

So the Federal Reserve controls the money supply so they can inflate the currency so that employment goes up, even if it is under false pretenses, but doing so causes price inflation thereby negating their other goal. All that can be done is a careful balancing act between falsely stimulating employment and causing price instability. Add minimum wage laws and you end up placing a floor on employment when interest rates aren’t causing excess employment. Now this doesn’t negate the claim that the Phillips curve is bogus as it’s supposed to be a general theory rather then interventionist based.

The solution for this is simple. Stop manipulating the money supply and ideally allow for a complete free market in money. A coworker today, while we talked about todays announcement from the Federal Reserve, said that they are damned if they do and damned if they don’t. That’s in regards to changing the interest rate. If they leave it it will spur more inflation and price increases and yet if they increase it to curb inflation there will be an even worse credit crunch. I made it clear however that it isn’t do or don’t but do or do. The Fed’s very existence is a positive action and distortion of the market place. They are incapable of “don’t”ing.

Related posts:

1. Inflation in U.S. Wanes?
2. Slowdown could have been avoided says idiot economist
3. Federal Reserve buys Treasury Inflation Protected Securities (TIPS)