Central Banking in a Democracy: The Federal Reserve and its Alternatives

243 Pages·2014·1.51 MB·English

by  John H. Wood

We heard from the chairman of the Federal Reserve that unless we act the finan-
cial system of this country and perhaps the world will melt down. . . . There was
complete silence for twenty seconds. The oxygen left the room. Chairman Bern-
anke said, “If we don’t do this tomorrow, there won’t be an economy on
Monday.”
Senate Banking Committee Chairman Christopher Dodd on a meeting of
legislative leaders with Bernanke and Secretary Paulson in Speaker Nancy
Pelosi’s office on September 17, 2008 (interview with Charlie Rose,
November 26, 2008)
These bad loans have created a chain reaction and last week our credit markets
froze – even some Main Street non-fi nancial companies had trouble financing
their normal business operations. If that situation were to persist, it would
threaten all parts of our economy. . . . We must now take further, decisive action
to fundamentally and comprehensively address the root cause of this turmoil.
And that root cause is the housing correction which has resulted in illiquid
mortgage-r elated assets that are choking off the flow of credit which is so vitally
important to our economy. We must address this underlying problem, and restore
confidence in our financial markets and financial institutions so they can perform
their mission of supporting future prosperity and growth.
Treasury Secretary Henry Paulson to the Senate Banking Committee,
September 23, 2008
“I do try to put a lot of weight on what people are saying,” Watt said, referring to
the overwhelming opposition of his constituents. “But in this case, I think a lot of
people don’t know exactly why a bailout is necessary. . . . On this issue, we [Con-
gress] have heard the top two economic authorities in the world tell us we’re on
the verge of a calamitous event.”
Mel Watt, North Carolina congressman, Winston- Salem Journal,
September 30, 2008
You never want a serious crisis to go to waste.
Rahm Emanuel, president-e lect Barack Obama’s chief of staff, Wall Street
Journal, November 21, 2009
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Central Banking in a Democracy
The Federal Reserve System, which has been Congress’ agent for the control of
money since 1913, has a mixed reputation. Its errors have been huge. It was the
principal cause of the Great Depression of the 1930s and the inflation of the
1970s, and participated in the massive bailouts of financial institutions at tax-
payers’ expense during the recent Great Recession.
This book is a study of the causes of the Fed’s errors, with lessons for an
improved monetary authority, beginning with an examination of the history of
central banks, in which it is found that their performance depended on their
incentives, as is to be expected of economic agents. An implication of these find-
ings is that the Fed’s failings must be traced to its institutional independence,
particularly of the public welfare. Consequently, its policies have been dictated
by special interests: financial institutions who desire public support without
meaningful regulation, as well as presidents and those portions of Congress
desiring growing government financed by inflation.
Monetary stability (which used to be thought the primary purpose of central
banks) requires responsibility, meaning punishment for failure, instead of a
remote and irresponsible (to the public) agency such as the Fed. It requires either
private money motivated by profit or Congress disciplined by the electoral
system as before 1913. Change involving the least disturbance to the system sug-
gests the latter.
John H. Wood is Reynolds Professor of Economics at Wake Forest University,
Winston- Salem, North Carolina, USA.
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69 Central Banking in a
Democracy
The Federal Reserve and its
alternatives
John H. Wood
Central Banking in a
Democracy
The Federal Reserve and its alternatives
John H. Wood