Would the United States Be Better Off Without a Central Bank?

October 12, 2011

Presidential candidate Ron Paul blames the Federal Reserve for playing a major causal role in the 2007-08 financial crisis and ensuing weak recovery.  Paul has been a critic of the U.S. central bank much longer than in the current business cycle.  His thinking on the matter was heavily influenced some 30 years ago by the classical liberal writings of the Nobel prize-winning economist, Friedrich Hayek.  Policymakers at the Federal Reserve have undeniably made some colossal blunders during its 98-year history.  The institution’s fingerprints were all over the Great Depression and the high inflation of the 1970s. 

It is one thing, however, to blame the actions and judgement of the central bank policymakers and quite another to assert that having a central bank institution does the economy more harm than good.  Ron Paul makes both accusations.  He would like to gradually replace the discretionary monetary policy of the Federal Reserve with a commodity-based system such as the gold standard.  It would be a radical departure and one that would set the United States apart from virtually all developed economies and many developing ones that have independent central banks. 

Paul’s proposal would be a reactionary step for the United States, which in 1913 established a true central bank later than many other countries had.  In its infancy, America had chartered a First Bank of the United States for the years 1791 – 1811 and Second Bank of the United States for 1816-1836.  Each functioned mainly like a bigger commercial bank to promote by example better standards of prudence among state-chartered banks.  Monetary policy as we now know it wasn’t practiced.  Ironically, President Andrew Jackson, whose picture adorns the $20 Federal Reserve Note, was an ardent opponent of central banking and made sure that the Second Bank’s lease did not get renewed.  For the ensuing century, the United States largely relied on various metal-based monetary systems to promote a stable currency externally and internally.

The romanticization of the period before the Federal Reserve conveniently disregards how tumultuous business cycles were during the nineteenth century.  Nineteen different economic downturns interrupted the 77 years between 1836 and 1913, comprising 56% of that whole interval.  A recession, by comparison, was experienced during just 5.3% of the twenty-five years through 2007.   Many U.S. downswings between 1836 and 1913 were enormous like the panics of 1837, 1857, 1873, 1884, 1893, 1896, and 1907, and they frequently had their genesis in dysfunctional banking.  In several of these instances, business activity contracted by more than 25%.  Price stability is a noble, but largely intermediate, goal. 

The greater purpose of economic stability is hard to secure with a monetary policy that’s always on automatic pilot.  When shocks inevitably befall an economy, one needs real people in the monetary cockpit with lots of education, training and sixth sense instincts to take hold of the controls.  Algorithmic rules just won’t do. 

Proper credentials matter, too.  Ron Paul’s original career and professional training was as an Obgyn.  A patient wouldn’t feel comfortable seeing certificates on her doctor’s office wall for a degree in economics.  And in the debate over whether the United States might do better with or without a central bank, the people of the United States ought to put greater credence on the opinion of a highly decorated economist like Ben Bernanke than of a highly decorated army general like Andrew Jackson or an MD and elected politician like Ron Paul.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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