Ferrara: The Fed Needs A Price Rule To End Wall Street Chaos

Peter Ferrara and Lew Uhler | Contributors

Getting a grip on the demand for and the supply of money is where the Fed is stumbling in deciding what interest rates should be, as it tries to return from its overlong frolic with “quantitative easing” zero-interest-rate policies. The result has been the recent “wild ride” on Wall Street.

After President Nixon cut the last link to gold in 1971, the 1970s became a nightmare of double-digit inflation and double-digit interest and mortgage rates. With no market guidance on money supply growth, that was the result of Keynesian reliance on seat-of-the-pants monetary policy.

Milton Friedman, a close advisor to Reagan, finally won the debate that the double-digit inflation of the 1970s was due to excessive money supply growth. Friedman advocated a fixed rule of money supply growth at 5 percent.

That would have worked in the 1970s to end double digit inflation, because Keynesians, for whom faster money supply growth was considered pro-growth policy, had dominated the policy debate for so long that the entire economy was predicated on double-digit growth of both the demand for and the supply of money.

Friedman thought the demand for money was so stable that it could be considered practically fixed. But as the Fed worked money supply growth, and hence inflation, down from the 1970s double digits after Reagan took office, the need for a surer guide to the demand for money became obvious.

For long term prosperity, money supply must equal the demand for money. But where can the demand for money be found? The answer is that you can only find the demand for money in market prices. And that is why the Fed stumbled onto the “Price Rule” during the Reagan era.

Back then, the Fed was trying to ramp down inflation, but trying not to overdo it at a time when it was also counting on the Reagan tax cuts to revive the economy after the stagflation 1970s. Just as today the Fed must not kill the economic growth the Trump tax cuts and deregulation have revived from the secular stagnation of Obamanomics.

Under the Price Rule, the Fed looks at the most sensitive market prices of precious commodities, such as gold, silver, copper, oil and others, to guide its monetary policy.

If those prices are falling, the Fed’s monetary policy is too tight, constraining money supply growth below growth in money demand. If those prices are rising, money supply is rising in excess of money demand, and monetary policy is too loose, veering toward inflation.

The goal is to keep the market prices of those commodities stable, which means money supply equals money demand. When the Fed was following that policy, the economy boomed for 25 years, from 1983 to 2008 without significant inflation or recession. It wasn’t until the Fed abandoned that policy, thinking it was smarter than markets, that the economy stumbled into the Great Recession.

If the Fed were to announce that it was returning to the Price Rule of the Reagan era, the economy and stock market would take off again. Unfortunately, in last week’s address by Fed Chairman Powell, the Fed indicated it was still following its own central economic planning and not markets.

The Fed holds $4 trillion in bonds left over from its wild party with Obama-era Quantitative Easing, buying up bonds with new cash to keep the economy from sliding back into deep recession. When it sells those bonds, it would be drawing money out of the market, which raises interest rates. That is what is scaring Trump’s recovery now.

The Price Rule can guide the Fed in how to do that slowly so it doesn’t raise interest rates too fast, and crash the recovery Trump has gotten started. It can sell those bonds only when the prices of those precious commodities are not falling, indicating there was enough demand for money to match supply.

The Trump economic boom could then continue for another 25 years like Reagan’s recovery starting in the 1980s, with monetary policy again pro-growth along with tax cuts and deregulation.

The top growth priority would then be to get control of government spending, deficits and debt, as well as resolving Trump’s trade policies. Then, we would have a completely pro-growth policy, just like Reagan did.

Uhler is founder and chairman of the National Tax Limitation Committee and National Tax Limitation Foundation (NTLF). He was a contemporary and collaborator with both Ronald Reagan and Milton Friedman in California and across the country. 

Peter Ferrara, a senior fellow with NTLF, teaches economics at Kings College in New York. He served in the White House Office of Policy Development under President Reagan, and as associate deputy attorney general of the United States under President George H.W. Bush.


The views and opinions expressed in this commentary are those of the author and do not reflect the official position of The Daily Caller.

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