Fed’s use of monetary policy as a yo-yo is a no-no

Thoughts about money:

❚ On Dec. 20 of last year, the Federal Reserve Board increased its key interest rate by a quarter of a percentage point. It was the fourth such increase in nine months.

At the time, the Fed was supposedly slowly unwinding the extraordinary monetary stimulus it engaged in following the panic in financial markets in 2008. As part of the creep toward normalcy, the Fed was also gradually reducing its holdings of Treasury debt and mortgage-backed securities.

On Aug. 1 of this year, the Fed reversed course. A quarter percentage point reduction was adopted and the shrinking of its portfolio was suspended.

The only thing that really changed in the economy in the interim was an escalation of President Donald Trump’s use and threat of tariffs. So, the Fed is essentially providing monetary policy support for Trump’s trade wars.

That’s ironic, given Trump’s Twitter tantrums against the Fed and its chairman, Jay Powell. It’s also an inappropriate role for monetary policy.

The short-term focus of the Fed in the aftermath of the financial market panic was understandable. But the recovery is now a decade old.

The Fed should have returned interest rates and its balance sheet to normal by now. And should be managing monetary policy for long-term stability and growth. Not using monetary policy as a yo-yo, trying to fine-tune quarterly economic fluctuations.

❚ The nomination by Trump of Judy Shelton to the Fed board has stimulated a discussion about what, if anything, should guide or restrict its management of monetary policy. Shelton has expressed support for a return to the gold standard and fixed currency exchange rates between countries.

Right now, the Fed flies by the seat of its pants. It supposedly considers a wide range of economic data points, throws them into a blender, and comes out with interest rates and market purchases designed to keep inflation at around 2 percent and employment at whatever its boffins deem full.

There are those who believe monetary policy should be more rules-based and not so freelanced.

I’ve never understood tying a currency to a single commodity, such as gold. The price of any commodity, even gold, fluctuates based upon supply and demand. Nothing has an intrinsic, unchanging value.

But the gold standard is not the only rules-based alternative. Pegging the value of the dollar to a basket of commodities would make more sense. Economist John Taylor has promulgated an eponymous rule for adjusting monetary policy based upon economic conditions, rather than the Fed just making it up as it goes along.

❚ The Austrian school of economics believes that the answer is competing currencies, eliminating the government monopoly over money. The United States will probably never go back to banks issuing their own notes. But we may get a dose of competition through digital currencies.

Facebook has an intriguing concept with its Libra digital currency. It proposes taking pains to ensure that it becomes a medium of exchange with a stable value over time.

Most other digital, or crypto, currencies have become primarily investment vehicles with wildly fluctuating values, rather than a medium of exchange. Bitcoin is the most prominent example.

Libra coins would be backed fully by government securities and bank deposits. Their exchange value would be effectively tied to a basket of government currencies in developed, stable countries.

Although Facebook isn’t stressing this perspective, it would compete with government currencies as a medium of exchange. Its advantage lies in being a truly global currency. Facebook also claims that it would have much lower transaction costs, making it more accessible to the unbanked and attractive to those residing in countries with dodgy banks.

Libra has gotten a hostile reception from the U.S. government. Regulators worry that it will be used to evade money laundering laws and conceal criminal activity. Members of Congress expressed concern about privacy, this being a Facebook initiative after all.

But Facebook has some other financial bigfoots on board, such as Mastercard, Visa, PayPal and eBay. It is open to regulatory oversight regarding law enforcement and privacy concerns.

A global digital currency that has a stable value as a medium of exchange has enormous potential for consumers. And its existence would act as a bit of a check on the competitive devaluations the central banks of the world seem to be drifting into.