Reform the Fed

Janet Yellen has betrayed the American people and will go down as one of the worst chiefs of the Federal Reserve in history. Her decision to raise interest rates earlier this week guarantees a continuing weak recovery, suppressed wages, and entrenched inequality.

In response, the left should add a central banking reform plank to its policy agenda. It's in part due to the institution's structure that its reform efforts are likely to be ineffective at best and destructive at worse. The Fed in its current form has become unresponsive to needs of ordinary Americans. It's time to change its outdated, century-old organization and give it new tools to manage the economy. Instead of creating trillions in new money, only to have it sit idle, it should send that money straight to the American people.

First, why is the rate hike bad? Since the financial crisis, the Fed has consistently failed to achieve either its mandate for low unemployment or its responsibility to keep the country's inflation rate stable. Instead it has tolerated extremely high unemployment, and simultaneously missed its inflation target for the past three straight years.

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By reducing interest rates, central banks can stimulate the economy and fight recessions: By making borrowing easier, they stimulate spending and investment. But rates can only go to zero (or slightly below) — and if that's not enough to get the economy re-pressurized, we're stuck. Under previous chair Ben Bernanke the Fed tried a few halting, half-hearted efforts at unconventional monetary stimulus, and while this "quantitative easing" was probably better than nothing, it was not enough.

In 2014, when the Fed wound down its unconventional stimulus, unemployment had approached something that looked close to normal (about 5 percent). Then it faced another choice: Hike early to stay ahead of inflation or let it ride and see how far the recovery could go?

This is a question of weighing relative risks. On the one side, inflation could come up more quickly than people anticipate. But raising the rate too soon risks choking the recovery in its cradle and preventing the creation of millions of jobs — remember, America is still missing about 3 points of prime-age employment (or roughly four million jobs) compared to 2007. What's more, a moderate amount of extra inflation would actually help the Fed by effectively making the zero interest rate floor further away (as inflation increases the real interest rate). Hence, as Paul Krugman argues, the smart move would be to wait until inflation is definitely beginning to tick up, and only then begin to raise rates.

Indeed, we've already run this experiment once before, in the late 90s. Then-chair Alan Greenspan, impressed by the computer revolution, decided he would not raise rates in 1996, hoping for an inflation-free economic boom. That's exactly what happened — and not even after a years-long period of economic weakness! Yellen herself was on the wrong side of this argument back then, arguing against Greenspan's move. She was wrong, yet seems to have learned nothing from it.

The absolute best-case scenario for this rate hike that it won't do much of anything.

This defeat stings all the more because it comes two years after liberals fought hard to put Yellen in the top spot at the Fed, over the Democratic Party establishment choice of Larry Summers. Since that time, Summers has been writing and speaking about the likelihood of current economic weakness being semi-permanent. Just before the hike he also wrote a piece about why he thought it was a bad decision. He very well might have been a better choice for the job.

It's also true that having the first woman in history appointed as the world's most powerful economic official is a good symbolic victory for feminism. It would just be far better if it didn't have to come at the expense of poor people, women, and minorities who are clustered at the bottom of the economic ladder — and hence suffer the most from a weak economy.

Despite Yellen's progressive resume points, she doesn't appear terribly good at making progressive gains. That might be due to the structure of the Federal Reserve, which is partly controlled by banks. The future objective for the left should be to bring the Federal Reserve fully under the control of the government.

Back when central banks were being first developed, it was thought they should be placed mostly beyond the reach of politicians, who would be endlessly tempted to stoke the economy right before election time, resulting in hyperinflation. It turns out this idea is badly mistaken. The Fed ought to be changed into a regular government department, so decisions could be made as part of cabinet-level discussion — and even overridden by the president if necessary. No more would private bankers, many of whom (like Neel Kashkari or Richard Fisher) are utterly daft, get automatic seats on the Fed monetary policy committee, as is currently the case.

Second, the Fed ought to be given the power to deposit newly printed money into individual bank accounts (something that would go well with proposals for postal banking). I've made this case at length, but here's the short version: Since 2008, the Fed has created trillions in new money, and much of it has quite literally sat idle in bank vaults. Putting that money directly into individual pockets would be a far more effective way to stimulate demand — and much faster than how monetary policy currently operates. No more waiting around for seven years to fix a hole in aggregate demand, simply flood the economy with cash until inflation begins to spike, and then pull back.

As the first two years of Obama's presidency shows, moments of political advantage tend to fade fast and hard. The left should have a big, aggressive policy package ready to go when the next one arrives — and Fed reform is something that will be useful for the next recession, and every succeeding one.