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Where Is the Diversity at the Federal Reserve?

It may be difficult to comprehend nine months of total inaction at the Federal Reserve as inflation took off to 40-year highs. But it is a feature of a system that has been overtaken by uniformity in methods and little tolerance for dissent.

The Federal Reserve Board of Governors, 2022.

It is no secret that the vast majority of economists failed to predict the price inflation ravaging our dollar-fueled global economy. Most unfortunately, this group includes all of the top economists at the Federal Reserve, the U.S. central bank with power over interest rates and the annual expansion of the money supply. Federal Reserve Chairman Jerome Powell infamously insisted for months that inflation was merely “transitory” – driven by supply-chain bottlenecks and therefore unlikely to stick around.

The Federal Reserve Open Market Committee (FOMC) consists of twelve high-ranking economists: the seven members of the Federal Reserve Board of Governors, including Chairman Powell, and five presidents of regional Federal Reserve Banks who rotate through one-year terms. With the unilateral power to raise and lower a key interest rate for banks known as the federal funds rate, the FOMC is effectively able to control borrowing costs for all consumers and businesses within the American economy. Higher interest rates tend to slow the economy by raising the price of borrowing and restricting consumption, therefore helping to bring down price inflation. But since interest rates directly affect the broader economy, setting this rate is a notoriously difficult task. Stock market equity valuations, credit card APRs, 30-year home mortgage rates, and yields on U.S. Treasury bonds, which determines the cost of financing our $31 trillion national debt, are all impacted significantly by the raising or lowering of interest rates.

Inflation began to pick up in April 2021, notching a 4.2% year-over-year increase in the Consumer Price Index (CPI). In March 2022, when the FOMC timidly raised rates from 0 for the first time, CPI had climbed to a staggering 8.6%. Yet even then, the FOMC would commit only to the minimum rate hike of 0.25%. It would take until June for the pace of rate hikes to ramp up to 0.75% – still a far cry from Paul Volcker’s decisive action to crush inflation in the late 1970s, when rates jumped up to 4% in a single month.

It may be difficult to comprehend nine months of total inaction at the Federal Reserve as inflation took off to 40-year highs. But it is a feature of a system that has been overtaken by uniformity in methods and little tolerance for dissent.

The academic discipline of modern economics is generally treated as a science much like physics or chemistry. Economists at the Federal Reserve rely upon empirical observation, statistics and mathematical models to analyze conditions and forecast future developments (primarily in inflation and unemployment), using those models to settle on appropriate policy responses (such as raising or lowering interest rates). But when their models prove wrong – even drastically – empirical economists rarely question the validity of their approach until it is too late.

With its economists fully dependent on similar macroeconomic models and identical empirical methodology, the Federal Reserve’s glaring inaction through March of 2022 was not an aberration. The data-driven consensus across all 12 Federal Reserve member banks overwhelmingly supported the conclusion that inflation was transitory. In December 2021, using their sophisticated modern economic models, members of the FOMC projected that inflation would average just 2.6% in 2022, as measured by their preferred gauge of the personal consumption expenditures index (PCE). The range of projections among member banks reveals little dissent; the highest projection was 3.1%. But in October 2022, PCE inflation hit 6.2%.

Similarly off the mark were projections for the federal funds rate, expected by FOMC members to reach 0.9% in 2022 and 1.6% in 2023. The maximum prediction for the 2022 federal funds rate was 1.2%; for 2023, 2.2%. But in November 2022, the federal funds rate hit nearly 4%. Since the federal funds rate serves as the key lever for taming high inflation, these projections are further proof of an uncomfortably uniform (and abysmally incorrect) expectation at the Federal Reserve for a rapid drop in price inflation. The actual data points for both PCE inflation and the federal funds rate come in at double the highest FOMC projections for 2022.

It is now universally acknowledged that our nation’s top economists made a series of critical errors in their mathematical forecasts and thus hesitated for nearly a year to decisively confront price inflation through rate hikes. But while most observers acknowledge this failure, they still underappreciate the degree to which policymakers at the Federal Reserve continue to use the same flawed, empirical framework. These unelected bureaucrats are arguably the most powerful group of people in the United States, but they are undeterred from their laser-like focus on aggregate levels of supply and demand, an intellectual habit which informs the mathematical models that repeatedly fail.

Remarkably, a wide array of reputable economists disputed the Federal Reserve’s narrative and successfully predicted lingering, elevated inflation. The largest of these dissenting factions points to a burgeoning supply of U.S. dollars as a critical driver of inflationary pressures, a situation often referred to as “too much money chasing too few goods.” Milton Friedman, who famously said that “inflation is always and everywhere a monetary phenomenon,” is known for focusing on the money supply as a key driver of inflation. With a record 45% increase in the M2 money supply from March 2020 through May 2021, many economists say Friedman was right, including former Federal Reserve Board Member Robert Heller and Nobel Prize-winning economist Larry Summers.

The federal government spent more than $5 trillion on massive coronavirus stimulus packages, primarily financed by government bonds that were then immediately purchased by the Federal Reserve, effectively injecting trillions of newly minted dollars into the U.S. economy. From Friedman’s monetarist standpoint, once the lockdowns ended and people could spend their stimulus checks, it was inevitable that price inflation would take hold so long as the money supply remained artificially elevated.

Numerous studies have revealed a direct cause-and-effect relationship between uncontrolled currency creation and debilitating episodes of hyperinflation in more than 2 dozen countries around the world. But mainstream economists are increasingly evading the possibility that large-scale currency creation can lead to a similar, albeit smaller, effect on prices in the United States.

Though the Federal Reserve carefully tracked growth in the money supply during the 1970s to set policy, this indicator has far less influence in modern models. Jerome Powell put it best in a February 2021 interview: “There was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time … The correlation between different aggregates [like] M2 [money supply] and inflation is just very, very low, and you see that now where inflation is at 1.4% for this year.” Despite being proven wholly incorrect, Powell has not walked back this statement, nor have any of the FOMC members since questioned their lack of emphasis on reducing the money supply as an effective solution to inflation.

Other economists take issue with the entire concept of stimulating the economy via artificially low interest rates, deficit spending and the creation of new money. These are students of the Austrian School of economics, a praxeological approach rooted in limited monetary intervention that once had broad appeal as an alternative to the now-ubiquitous Keynesian approach that promotes government stimulus and long-term currency devaluation. Rather than treating economics as a science, Austrians hold that the economy is a complex, highly variable web of human interactions that cannot be centrally planned through any number of mathematical models.

Mainstream economics has become dogmatic and lacks serious diversity of thought. Virtually no college economics class in the 21st century treats Austrian heavyweights like Ludwig von Mises, Friedrich Hayek or Murray Rothbard as legitimate thinkers worthy of even a single chapter in an introductory textbook, let alone a seat on the Board of Governors at the Federal Reserve. Yet each and every one of them would not only have accurately predicted that inflation would linger beyond the summer of 2021, but that it was inevitable, from the passage of the very first torrent of Covid-era stimulus foisted upon us by Congress and the Federal Reserve.

For good reason, the Federal Reserve is often referred to as the fourth branch of the United States government. The power to slow and stimulate economic growth with the flip of a switch is envied by politicians. Decisions made by the FOMC hold dramatic implications for consumer purchasing power, unemployment, GDP, the stock market, and the quality of life for families and businesses. The consequences of bad monetary policy can be monumental, and those in power should not dismiss all dissenting opinions and schools of thought as fringe – particularly after their recent failure to project and counter persistent high inflation. Whether it is a Friedmanesque monetarist approach, a revival of Austrian economic principles, or another credible contrarian view, it is critical that the central planners of our money at the Federal Reserve not only allow, but actively encourage a lively debate over both the theoretical fundamentals and gritty methodology that informs their key decisions.

Without diversity of opinion at the Federal Reserve, we are ever more likely to find ourselves mired once again in the spiraling stagflation of the 1970s – but this time with no way out.


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