Money and the Rule of Law

EconBuff Podcast #50 with Alex Salter

https://youtu.be/tRk01ILgPbI?si=RPyoMf5RmGUtAF2D

Dr. Alex Salter talks with me about his book Money and the Rule of Law. Dr. Salter explains the major problems with current monetary policy execution. Dr. Salter argues that central banks struggle to implement monetary policy effectively because of discretion on the part of the central bank. We explore Salter’s main argument in the book, that the Federal Reserve should not make its own goals, but that the democratic process should more tightly define the Fed’s objectives. Dr. Salter lays the framework out for how the paradigm of monetary policy should be redefined, where the rule of law should provide the foundation for monetary policy, removing discretion over the goals of the Fed. Finally, we explore Dr. Salter’s recent opinion piece where he argues that the FED should stop lowering interest rates even though inflation was 3.7% at the time of his writing.

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Transcript:

LEE STITZEL: Hello and welcome to the EconBuff Podcast. I'm your host, Lee Stitzel. With me today is Dr. Alexander Salter from Texas Tech University. He's the Georgie G. Snyder Professor at the Rawls College of Business and a Comparative Economics Research Fellow at the Free Market Institute. He has several books, one of which is the topic that we're going to discuss today, which is Money and the Rule of Law: Generality and Predictability in Monetary Institutions, written alongside Peter Boettke and Daniel Smith. He also has a recent book titled The Political Economy of Distributism: Property, Liberty, and the Common Good. He has over 70 academic publications, and he writes frequently for National Review, The Wall Street Journal, and the American Institute for Economic Research. Alex, welcome.

ALEXANDER SALTER: Lee, great to be back. Thank you.

LEE STITZEL: So, what I want to start us off with today is: what is, in your view, the main problem with how monetary policy decisions are currently made?

ALEXANDER SALTER: Great place to start. My main issue with how we make monetary policy decisions in this country, and in many other countries, is that it is far too discretionary. Central bankers have too much leeway to make period-by-period decisions unconstrained by any rule or underlying framework.

Here's why that's a problem. The economy is constantly in flux, and at best we're making decisions based on immediately past data. Discretionary monetary policy is like trying to throw darts at a dartboard while blindfolded, with a moving dartboard. It's just never going to work. If you're relying on the discretion of the monetary policymaker, they're going to make mistakes. They're going to pass those mistakes on to other people in the economy. There's going to be economic problems. It's a very tough job that really can't be done well. So I think that we need major institutional changes to how central banks work to fix these problems.

LEE STITZEL: So what are the main problems there? What is it that makes it so difficult for them to make good decisions, and why is it so hard? Why the moving dartboard, so to speak?

ALEXANDER SALTER: The economy is the dartboard. It's constantly in flux. There's always new developments in the economy. Markets are changing. Entire sectors are changing. And again, when central bankers meet to make decisions about interest-rate targets, or about what's happening with the money supply, or whether they need to conduct emergency lending policy, they're always looking through the rearview mirror, so to speak. It's never going to be an accurate representation of what's going on in the future.

Now, of course they try and forecast these things, but it's no good trying to pretend that you can out-market the market. We really shouldn't be subsuming the social intelligence of the marketplace to the private intelligence of bureaucrats as central bankers. If we could actually do that, then we wouldn't need private property and markets to coordinate the economy in the first place. It's really a hubristic exercise to think that discretionary monetary policy, monetary policy unconstrained by rules, can outperform a more lawful, regular monetary system.

LEE STITZEL: So they're looking back at past data, and then they're trying to forecast what they think is going to happen, and that's what's principally causing them to not be able to make good decisions?

ALEXANDER SALTER: It's one of the factors that makes it difficult to make good decisions. The forecasting problem by itself is not the only problem. There's also the problem that central bankers might not face the right incentives in terms of their day-to-day implementation of monetary policy.

Think about a key monetary-policy decision-maker who's facing a choice between erring on too loose of monetary policy and too tight of monetary policy. There's always the risk that if you go too tight, you're going to have a financial crisis or major economic phenomenon, a major economic meltdown, on your watch, in which case you go down in the history books as a central banker who let the second Great Depression happen. And you never want that. So, of course, your incentives are, the second that financial markets look turbulent, to err on the side of being too loose, which means that we get persistently easy monetary policy. We get persistent inflation.

Obviously, we just lived through a major inflationary event that's only just now slowing down, but this is a predictable consequence of the incentives that are baked into the system. The two major kinds of problems that discretionary monetary policy has are those incentive problems and the more basic information problem that we talked about, too. You need to have access to something like a feedback loop to tell you when you're making good decisions about policy. Monetary policy has no robust feedback loop. It's why we're always taking shots in the dark.

Rather than trying to out-market the market, a better approach would be to set the basic course for monetary policy in terms of a rule-like framework and then allow the market to adapt to that, instead of constantly trying to tinker with things in top-down fashion.

LEE STITZEL: So you're saying the alternative to this discretion is a rule-like approach. Can you kind of expand on that? Tell us what these rules might be, where they might come from, and maybe how they would work.

ALEXANDER SALTER: Oh, sure. There's lots of frameworks for monetary policy that you could embrace that embody what we call in the book a monetary rule. And that's not even a special term that economists use, right? That's one that the person in the street probably immediately understands what that means. It is a rule for what happens to monetary policy. It's a regular, lawful process that can be made predictable, intelligible, and non-discriminatory, in the sense that it's supposed to benefit everybody in the economy rather than special-interest groups.

Now, one way that you could get a monetary-policy rule is actually have Congress step in and say, "We're going to get the Federal Reserve to adopt, say, a 2% inflation target. We're going to compel the central bank to try and hit 2% inflation every time period, every year," for example.

Right now, Congress has legislated that price stability is the goal of monetary policy, but the legislature has thus far failed to specify exactly what that means, which leaves a lot of leeway for central bankers to determine for themselves, well, how fast or slow should inflation be in order to qualify as stable? That's the whole problem. You don't want to leave central bankers that leeway. You want to bind their hands as tightly as possible. The job of central bankers should be carrying out a narrowly specified mandate that's made by the legitimate constitutional authority, which in the United States is Congress. Central bankers should not be deciding for themselves what goals they pursue. They do not have that authority, politically speaking, although they've been operating with that authority on a de facto basis for decades.

LEE STITZEL: So I want to come to that in a minute, because I'm very interested in this idea of how those decisions get made and whether that really does reflect, like you said, the rule of law. But just kind of briefly, then, I think a listener might say, well, if the central banker has to look back and then forecast and then make decisions, how does a monetary rule solve that? Doesn't that have the same problems? It also has to use past data. So how do you solve that sort of moving-dartboard problem with a monetary rule instead of discretion?

ALEXANDER SALTER: The way that you would do that, as long as you have a central bank, is to pick a variable that is denominated in dollars. Because again, in the U.S. economy, where do dollars come from? If you pull a dollar out of your wallet and look at it, somewhere on that dollar bill it's going to say Federal Reserve Note. All money is right now is a liability of the central bank, and the Federal Reserve ultimately controls how many of its liabilities are in circulation. So they control the most narrow measure of the money supply, what economists call the monetary base.

Because of that, the Fed can credibly commit to a future growth path for a variable denominated in dollars. Think about the price level, right? An index number that tells you how expensive goods and services are in general. In other words, the growth rate of the price level is a very familiar thing for us. That's inflation. That's where inflation comes from. It's the growth rate of the price level.

So if the Fed wanted to, it could say, "We're not going to do period-by-period decisions about what we think interest rates should be, what we think the money supply should be. We are going to make sure that the price level, according to however they want to measure it, grows at 2% per year, and we're going to do whatever is necessary to actually hit that number. And furthermore, we're going to make up for our mistakes. So if we're a little bit too loose this year, we'll be a little bit too tight next year, so that on the long-run average it's going to be a 2% growth in the price level."

That creates stability, and market participants can then write their contracts based on that. It's much easier to write a long-term financial contract if you know what's happening to the purchasing power of the dollar, because you can bake that into the interest rates that you demand on your securities yields, right? If you and I are on the opposite side of a debt contract, if I'm loaning you money, you're borrowing money from me, and we both agree that over the term of the loan there's going to be 2% inflation, then we can just bake that into the interest rate, because it's a wash for both of us.

The whole point of having a central bank, if you have a central bank, is to create what we call in the economics field nominal expectational stability. Nominal means referring to figures measured in current dollars. Expectational means we're trying to satisfy the market's beliefs about what is credibly going to happen in the future.

Think about it like gardening. A gardener does not tinker with plants and force them to grow. A gardener sets the background conditions under which healthy growth can occur. That's how we should think about central banking. We are not engineers. We're gardeners. And that's how we should think about a monetary rule.

LEE STITZEL: So should the central banker, in that case, what they're trying to set, is it the variables they can actually control, the monetary base, or is it the eventual outcome, the inflation?

ALEXANDER SALTER: The outcome that they're trying to hit is a given growth path for the dollar's purchasing power. Their instrument, or what they use to actually try and achieve the goal, is probably going to be some combination of the monetary base and a short-term interest rate.

You've probably heard, in a news headline, something will say, "The Federal Reserve raised interest rates." What that actually means is they have a target for a specific interest rate called the federal funds rate, which is the rate that banks will lend to each other on an overnight basis to make sure that they have enough short-term reserves to conduct monetary policy. The Federal Reserve tries to influence that rate to make sure that it matches underlying economic fundamentals. So, using that and the monetary base, the Federal Reserve would try and create a stable, credible, and predictable growth path for how much stuff, on average, the dollar could buy.

LEE STITZEL: Are you saying this is not what the Fed has been doing?

ALEXANDER SALTER: The Fed has been doing this on a highly discretionary and unpredictable basis. They refuse to commit to any underlying growth path for the dollar. They refuse to specify whether they think inflation has been too high or too low over any given concrete period of time.

Now, don't get me wrong. When inflation was 9% last summer, or whatever it was, you had all the central bankers at the Fed saying, "Yeah, that's too high." But they've never, not once, told us what specifically they want it to be on a one-year, two-year, five-year, long-term basis. That introduces way too much noise.

Think about how big the Fed-watching industry is. There are entire careers whose job it is just to watch central banks, read their press releases, to try and outguess them. It should never be a mystery how a central bank is going to respond conditional on new economic data coming in. You should be able to say, "Oh, the Fed is going to do XYZ things." The fact that you can't answer that question is pretty good evidence that the Federal Reserve is, on purpose, keeping its cards too close to its chest, because in many ways they see their job as outsmarting the market. They're trying to tinker. They're trying to improve things. They're trying to be engineers. We don't want to be engineers. We want to be gardeners.

LEE STITZEL: That's excellent. So now let's turn and look a little bit at that rule-of-law idea that you're talking about. I forget exactly how you worded it now, but you're saying, well, the Fed is making these decisions, but it's not just decisions about how to sort of follow some kind of mechanism or monetary rule. They're deciding what it is that they're even targeting, what their goals are, in addition to maybe how they would get there. So just briefly, then, explain to us what the rule of law means for monetary policy and monetary-policy rules.

ALEXANDER SALTER: The rule of law, as applied to monetary policy, means that the ultimate goals of central banking are not up to central bankers to decide. The Federal Reserve has no independent constitutional standing in the United States. What I mean by that is its authority is delegated from Congress. The Constitution vests monetary powers in the Congress. The Congress has decided to use the Federal Reserve as an agent to try and achieve some monetary objectives.

In the 110-plus years since we've had the Federal Reserve, it has taken on for itself a de facto role of deciding not only what the proper instruments are, but what the proper goals are of monetary policy. And that is not a legitimate exercise of public political authority. Those decisions should be made by the people's representatives in Congress assembled.

And so, by a monetary rule, we mean that some framework for monetary-policy decision-making that concretely specifies what the objectives of monetary policy are needs to be handed to the Fed. And the Fed's job, as an agent, is to try to satisfy its principal. And if it strays outside of that box, outside of that fairly narrow mandate, they should be accountable for that. They should be liable for not only questioning before Congress, but dismissal.

LEE STITZEL: So you're not just saying, well, it would be better if the Fed wasn't also, because it introduces all this uncertainty, they weren't also trying to decide what their goals were. You're saying there's a fundamental political reason for that as well. Is that right?

ALEXANDER SALTER: Yes, and I want to make sure that your listeners understand, when I say political, I do not mean partisan. I mean publicly accountable. Democratic accountability is ultimately what we're after here. This isn't a Republican thing. This isn't a Democrat thing. This isn't, you know, insert your preferred third party here thing. This is about the basic justifications we use to authorize public power.

And right now the Federal Reserve is basically operating as a law unto itself. It's not constrained in any meaningful sense by the public authorities who, on paper, have legitimated it. And I think that that's a problem not only because it creates bad economic consequences. Don't get me wrong, it does. It is bad for the economy. But it also is in stark tension with the fundamental principles of democratic self-governance that underlie the American experiment. So we have reasons to care about this even apart from the bad economic consequences.

LEE STITZEL: So you'd be in this camp with this position, if you will. I'm using too partisan language, so I apologize for that. You would hold these beliefs even if it were the case that the Fed could effectively do it, didn't have the problems with discretion, even if it could effectively use discretion to do this. If it were still picking its goals, you would say that's problematic because the people, through the democratic process, should pick the goals.

ALEXANDER SALTER: That's right. So one way of thinking about this is the procedural objections, and that's the rule-of-law thing, stand independently from the economic consequences. Even if, assuming arguendo, the Federal Reserve could perfectly engineer full employment, stable output, stable inflation, all that stuff—we know that it can't; it's failed too many times to count—but even if it could, there would still be this legitimacy problem.

It's not theirs to decide how the dollar's purchasing power changes. It's not theirs to decide what issues they use their monetary-policy tools to pursue. Just in recent years, the last five, ten years, the Federal Reserve has gotten involved with policy issues that have nothing to do with money and credit. They're now getting involved in climate-change policy, and we know this because they say they're doing it in their statements. They're getting involved in looking at the different unemployment rates between different ethnicities, right? So they're not looking at the average unemployment rate anymore. They're looking at, for example, the minority unemployment rate, saying that's specifically too high.

I want to be clear: climate change and environmental policy and racial/ethnic justice are perfectly valid policy areas. We can and should deliberate these things. But nowhere, nowhere has the Congress of the United States delegated to the Federal Reserve the authority to weigh in on those topics. The place we decide policy about racial equality and climate change is Congress. It is not the central bank, whose narrow mandate—which is already far too broad in my view—but whose already narrow mandate has nothing to do with these things.

The day before yesterday, nobody would pretend that these things have anything to do with monetary policy because they know that they would be laughed at. And now we have central bankers who are trying to convince us, "Oh yeah, these are valid goals for monetary policy." No, they are not, and they know they are not.

LEE STITZEL: So, just as an almost an aside, if you will, what we'd like to see probably is some version of Congress comes along and says, "This is your very narrow mandate. It's monetary policy. Use these tools, hit this target," and then we would have this kind of certainty and better efficacy as well that would actually get us down that path. But hypothetically, if Congress wanted to say, "Okay, your mandate is 2% inflation plus insert some policy here"—I'm not going to pick one, just to keep this kind of open-ended—that would then at least be legitimate, even if they couldn't do that effectively, right?

ALEXANDER SALTER: If the Congress of the United States told the Federal Reserve that, as part of its banking-supervision authorities, it was to discourage financial intermediation related to fossil fuels, it wanted them to use their financial powers to discourage the fossil-fuel industry, I would object to that in terms of consequences, but I would have no legal or constitutional objection to that. The whole point is that Congress can give the Fed that authority if it wants to, and it hasn't. And despite the fact that it hasn't, the Fed is doing it anyway. That's the problem with that specific issue.

LEE STITZEL: So I want to kind of get now into some specifics, right? In the chapter where you're talking about this in the most depth, you're talking about generality, predictability, and robustness. Can you kind of define each of those in turn and then tell us why those are important in the context of rule of law?

ALEXANDER SALTER: Yeah. So that comes from the chapter in the book where we talk about this idea in the economics literature called robust political economy. And basically that means we're looking for governance rules that work well even if people have less than perfect information and face less than great incentives.

A lot of times, if you read economics papers, economics books, journal articles, they'll assume, well, we'll assume that the government has all the relevant information and that the government's sole interest is maximizing the public welfare, and then they'll try and devise optimal policy based on that. That's an interesting intellectual exercise, I suppose, but it doesn't really have any relevance to the real-world policy process, because in the real world we never have anything approximating complete and perfect information, and in the real world public servants often face some pretty bad incentives. We all have seen the increased acrimony in public life over the past five, ten years. I don't think that anybody could safely assume that public servants are angels.

Robust political economy is premised on the idea that we need to find rules and institutions that work well even if the people who govern us are evil and stupid. So we need to assume the worst possible incentive and information environment and then figure out, okay, what rule can we live with even if that's the case, right? Even in that world.

So, when we talk about generality, we mean in the book that we need to find a monetary rule that works for the general population. It's not just good for Goldman Sachs. It's not just good for Wall Street. It's not just good for politically connected financial and quasi-financial firms. It's good for the entire economy, meaning it creates a stable foundation for economic activity in general without having specific winners and losers.

Predictability means exactly what the word suggests, right? You should be able to anticipate the stance of monetary policy going forward. You need to be able to forecast what the central bank is going to do because you need that information to be baked into financial contracts today if you want to get the most efficient and effective capital allocation possible. And this isn't just an abstract thing, right? Capital allocation, making investments, building new infrastructure, technologies—this is the source of long-run economic growth. And so we need to get that stability and predictability in there so we can get the most out of our economic system, both in terms of short-term stability, preventing business cycles, recessions, and in terms of long-run growth, long-run performance.

And robustness is exactly what we talked about beforehand. We need to find a system that works tolerably well even if the people who exercise power are ultimately not that well informed and even if they're selfish and narrowly concerned rather than concerned with the public welfare. We contend that the more rule-based monetary policy is, the more it satisfies those three criteria.

Now, that doesn't mean that all rules are equally good, right? The content of the monetary rule definitely matters. We don't actually pick in that book a specific rule. We're arguing for rules as such. Obviously, we can think about a monetary rule that, if it were followed, would be devastating for the economy. We're not advocating picking a bad rule, right? We are saying that we need to reappreciate the discipline that rules create for macroeconomic policy in general and monetary policy in particular.

LEE STITZEL: So just to clarify, right, because we're talking about rule of law and monetary rules. So far you've said we need to have rule of law at play here, and we need that because for the Fed to be a—you said legally, right?—legally or constitutionally legitimate process, it needs to have this, oversight's not strong, but this strong guidance from the democratic process itself. Are you saying Congress needs to pick a rule, or can they be handing goals? And then how would you settle on a rule? So, like, the most popular rule probably is the Taylor rule, right? So if we follow that, are you saying Congress should hand the Taylor rule to the Fed and say, "Execute this," or who's picking the monetary rule, I guess, is what I'm asking.

ALEXANDER SALTER: What I would like to see personally is for Congress to pick the target. I would like Congress to say, "We want you to pursue a stable dollar, and by stable we mean X% inflation." X can be 2% per year. X could be 0% per year. A lot of economists think that you need a little bit of inflation every year to grease the skids. It's not true. 0% inflation would work just fine as long as the market knew that that was the rule and everybody expected it.

The Taylor rule, which is a rule showing how short-term interest rates should change based on inflation and unemployment, is what we call in the economics literature an instrument rule. It's kind of like a rule of thumb or a map for central bankers. I don't think that Congress should get involved that specifically at telling the central bank what instruments it should use. The whole point of having a central bank is that you do have some people with legitimate expertise in monetary policy conducting monetary policy.

I think it makes perfect sense for Congress to say, "Fed, this is the goal. We're in charge of the dollar. It's our constitutional responsibility. We are delegating to you the authority to execute a strategy to achieve this goal. You have a lot of leeway in terms of the strategy. You have no leeway in terms of the goal. We choose the goal. You are our agents. We are the principals. You're hired to do a job, which is create a stable dollar, and by stable dollar we mean this."

The problem is that Congress has thus far refused to specify what they mean by this, right? They've passed legislation saying the Federal Reserve's job is, quote, "full employment and stable prices," unquote. But that's hopelessly vague. What does stable prices mean? How much inflation is stable prices? How much employment is full employment, right? Get ten economists to answer that question and you'll get 30 different answers. So we need much more concrete guidance, I think, from the ultimate constitutional authority here about what the proper public goals or targets of monetary policy are.

LEE STITZEL: Do you think it matters much what that goal is? Like, if this kind of constitutional rule comes down and Congress says, "Give us 6% inflation per year," this seems like kind of a bad outcome.

ALEXANDER SALTER: I definitely have preferences over the content of the rule. I don't think that anybody would want to see 6% inflation every year because even if you perfectly anticipate that, that is going to have some economic cost in the sense that inflation is, among other things, a tax on using cash. And so you're going to see some diseconomies in terms of divesting from cash in an inefficient way.

But it turns out that inflation is massively politically unpopular. I think that some people have found that out the hard way in the last two to three years. So I'm not too worried about Congress picking an inflation target that has too much inflation in it. My worry would be Congress looking like it's doing something while continuing to be vague, or Congress passing the kind of authority that I want while refusing to enforce it, and everybody sort of just understands that they're going to look the other way because it's not worth their while to get involved in that fight.

It's notoriously difficult for legislators who are generalists to hold specialists like central bankers to account, to keep them responsible, because usually 99 times out of 100 the expert knows more about their subject matter than the congressperson who's questioning them when it comes time to give testimony. And so, because of that, disciplining the bureaucracy, in which I include the central bank, can be difficult. But I would be more worried about these other kinds of informal, you know, political games than I would be about Congress picking a bad rule.

LEE STITZEL: I mean, we've had a recent episode of high inflation. Unless I missed it, I don't see where there's been any congressional oversight where they're trying to bring the Fed to account for this. They should say, "Oh, there's 9% inflation. What are you doing?"

ALEXANDER SALTER: Yeah, there's a lot of calling in the Fed chair, and they'll yell at him on camera so they can put it in their donor reel, and then nothing really happens. There's no meaningful accountability. The people who make monetary policy can just shrug their shoulders and say, "Oops, we'll do better," and we kind of have to take their word for it because there is no other option. There's no actual way of disciplining monetary policymakers when they make mistakes.

It's also worth pointing out, since Congress hasn't said what stable prices are, we don't know what mistakes are, right? Everybody sort of understands that 9% inflation is unacceptable. What about 4% every now and then? Is that acceptable? Is that not acceptable? I don't know, and the problem is nobody knows because we don't actually know what the standard is.

LEE STITZEL: Do you think there's been some—I mean, a lot of this is political—but do you think there's been some kind of de facto punishment, if you will? We've seen some Fed chairs that are around a long time. I mean, how long was Greenspan chair? And then the recent few chairs have only lasted a few years. Are they getting turned over for political reasons, or do you think this kind of is some Congress saying, "You guys are not doing a particularly great job, and so we're not going to keep you around for very long"? And it seems like Powell probably won't last the next election cycle either.

ALEXANDER SALTER: I think we've got a case of meet the new boss, same as the old boss. I don't see much difference in terms of the concrete outputs of monetary policy between Bernanke and Yellen and Powell. They're all too dovish for my taste. They all favor activist central banking.

It's true that inflation blew up on Powell's watch, but I think that that could have just as easily happened to Yellen or Bernanke if the circumstances had been different. A lot of people have made hay out of the fact that Powell is not an economist. He's a lawyer who worked as an investment banker for a long time. Frankly, professional economists have not made great Fed chairs. They've made their share of massive mistakes as well.

I would argue that the slow recovery since the 2008 financial crisis should be blamed primarily on Ben Bernanke's Fed, precisely because they implemented a new system for conducting monetary policy where they paid banks not to conduct financial intermediation. Like, they created all this liquidity to stabilize the economy, and we still got a massive, deep recession after that because all that liquidity stayed parked in bank vaults. Why? Because the Fed paid banks not to lend out the money. Well, shocker, if you pay people money, they tend to do more of the thing that you're paying them for. You pay banks not to lend, they're not going to lend.

So every single Fed chair, including Greenspan, including people before Greenspan, have made mistakes. I think the problem is, one, the macroeconomics profession as a whole just isn't as smart today. And by that I don't mean that they're actually, like, lower IQ or anything. I mean that there's been a collective loss of knowledge about how the economy operates today that we had, frankly, 30, 40 years ago that seems to be going away. And I would argue that the meaningful constraints on central bankers are weaker today than they were generations ago.

LEE STITZEL: And that loss of knowledge about the economy, is that stemming from changes in the economy and economists not being able to figure out mechanistically how things seem to work in the modern economy, or are you saying there's a different reason for that?

ALEXANDER SALTER: I think there's a different reason. It's not just so much structural economic change, but the way that economists think about monetary policy has fundamentally changed. A generation ago, you still had economists who understood that liquidity and credit and the money supply mattered. Today, everybody thinks of monetary policy solely in terms of interest rates. They are incapable of conceiving the money supply, or any of the broader monetary aggregates, mattering for economic performance.

And really what happened is they kind of got fooled by the decade that we had since the 2008 financial crisis. Since the Federal Reserve did undertake extraordinarily expansive monetary policies, right? It expanded its balance sheet a ton, but the money supply didn't go up. And so, from that, macroeconomists thought, "Oh, well, you know, the balance sheet must not matter. We can make the balance sheet grow as large as we want. The Fed can print up new money, spend it on whatever, and there's not going to be inflation." Surprise: there was tons of inflation, right?

This basic link between the balance sheet and the money supply, and between the money supply and inflation, right, this thing that we're still teaching our freshman macroeconomics students, day one undergrad, somehow escaped an entire army of the smartest PhD economists in the world, which is pretty good evidence that the Federal Reserve should not have as much discretionary authority as it actually does.

Right? Remember that famous Milton Friedman quote: any committee of people, no matter how well-intentioned, that can do that much harm just by making honest mistakes has too much power. Human beings are fragile. We're fallible. This is a really hard thing to do. We're going to make mistakes. We need a system that minimizes the cost of those mistakes, and right now we don't got one.

LEE STITZEL: So I kind of want to get into how that goal—like you said, you don't want Congress to give directions on instruments, but you want them to give a goal. Would you like to see something as specific as, "We want 2% inflation, and you have a certain time span in which it can be out of that, and then if it doesn't fall, then you're out of your job"? Something that specific, or how do you view that?

ALEXANDER SALTER: Something towards that. I would be okay with Congress picking a specific inflation target. I would also be okay with some disciplining mechanism in the sense that if inflation got off target for too long, then procedures would automatically trigger to change the chairperson of the Federal Reserve and perhaps some other voting board members as well—or I should say voting members of the Federal Open Market Committee, the people who make the main monetary-policy decisions.

I'm not wedded to a specific rule. I have a range of ones that I like. And I'm not wedded to a specific accountability mechanism. I've got a range of them that I like. My position is, right now there's clearly no accountability. Once you're nominated by the president and confirmed by the Senate, you're basically there until your term's up. It's very, very difficult, if not impossible, to discipline bad central bankers.

And we're just sort of, again, driving around in the dark, not really sure which way we're going because we don't have any guidance for what monetary policy is supposed to do. So we can't even hold people to account until we know what the standard is. So Congress really needs to step up on that one before they do anything else.

LEE STITZEL: So you've been very generous with your time, so I do want to bring this in for a landing, kind of finish with some current events, if you will. So you have a recent opinion article in the American Institute for Economic Research where you argue that, despite inflation numbers being above 2%, supposedly the Fed's announced target, right, that they shouldn't hike interest rates, at least not yet. So how do you square this with monetary rules, and kind of just give us your breakdown on where we're currently at with inflation and why you suggested that.

ALEXANDER SALTER: Yeah, so we've come to the ironic part of the show, right? I've just spent the last half an hour telling you why monetary-policy discretion is bad, and here I am giving advice to monetary discretionary policymakers, right? So there's some tension there.

As long as monetary policy is going to be discretionary, there's better and worse ways to do that, right? Ultimately, I don't think it should work the way that it works. But as long as the rules of the game are what they are, it's reasonable to try and make things work as least badly as possible. I think that hoping for well is probably beyond us at this point.

The reason that I counseled against further monetary tightening is because, based on everything that I can tell, monetary policy is already sufficiently tight. We just had new CPI data come in today, right? Core inflation was 0.3% per month. That's roughly 3.6% per year. Not as low as we would like, but lower than it's been.

The other price index, which is called the PCE, Personal Consumption Expenditures—this is the one that the Federal Reserve watches most closely—recently came in at a headline rate of 0.1% per month. That's only 1.2% inflation per year. And again, that excludes food and energy prices because those are notoriously volatile, and so I think that excluding those prices gives us a better picture of underlying inflation dynamics in the economy.

So if that's an accurate picture of recent inflation and you look at inflation-adjusted interest rates, they're significantly above the rates that, as far as we can tell, would be neutral. Economists have come up with all sorts of tools and techniques to try and estimate, like, what interest rate is consistent with full employment in terms of full use of the economy's scarce resources, so the economy is neither overproducing nor underproducing. And the short-term rate that does that is somewhere between 0.5% and 1.15% after adjusting for inflation.

Right now, interest rates in the economy after adjusting for inflation are somewhere between 1.5% and 2%, so above that. I think that that's an indication that the Federal Reserve has already done what it needs to do to bring inflation down at a reasonable rate.

That doesn't excuse them, right? The whole reason that we had 9% inflation in the first place is because they let the horse out of the barn, right? They left the barn door open. You don't give a guy that much credit for cleaning up the mess that he made. That's kind of, like, the least that he can do.

What I want the Fed to do, though, is not make another kind of mess. There can be messes from running too loose, and there can be messes from running too tight. And if we're always fighting yesterday's wars, when circumstances change and we overtighten, right, then we might just cause an unnecessary economic slowdown.

Interest-rate data is only one part of the picture. Look at what's happening with the money supply. The money supply is falling right now at a rate of about 3.5% per year. In other words, the money supply today is 3.5% smaller than it was on this day a year ago. The money supply has not fallen at all in recent decades. This is the first time this has happened as long as anybody can remember. That's extraordinary.

Broader measures of the money supply, things that don't just count up dollars in checking accounts and savings accounts but actually weight these things in terms of how liquid they are, right, because a checking account and a savings account are not equally liquid, they also show continuous decline in the money supply. Not as large, but it's still negative. We have negative money growth.

Again, this is very unusual. This, I think, is an acceptable thing to get control of inflation over the short run, but I'm worried that the Fed is going to overreact to its overreaction, right? We just get an escalating series of errors. The Fed overreacted to COVID, right, which is why we got inflation, and now the Fed's at risk of overreacting to its overreaction, which might cause the economy to actually get too tight.

So we're constantly veering between too tight, too loose, too tight, too loose, and we're just throwing the economy for a loop, right? It's basically a one-two punch. And I think that people deserve to not get punched in the face for a little while. So how about we shoot for neutral? How about we calm down? How about we wait and see for a little while and then make sure that we actually have an accurate picture of what's going on?

Now, the reason, again, this is so hard is because we have no choice but to try and find the least bad discretionary decisions as possible. I would much prefer to automate this. I would much prefer to just pick an inflation target and say, "Go get them." But as long as we're not going to do that, I think that this is the best advice you can give.

LEE STITZEL: My guest today has been Alexander Salter. Alex, thanks for joining us on the EconBuff.

ALEXANDER SALTER: That was a lot of fun, Lee. Thank you.

LEE STITZEL: Thank you for listening to this episode of the EconBuff. You can find all previous episodes on YouTube at EconBuff Podcast. You can check out our website at EconBuffPodcast.wixsite.com. That's Wixsite.com. You can contact us at EconBuffPodcast@yahoo.com.