A private committee for monetary reform: process and substance.

• Author: O'Driscoll, Gerald P., Jr.
• Position: Essay

In this article, I propose establishing a private Committee for Monetary Reform (CMR), outline a process for advancing fundamental reform, and suggest what the substance of that reform might look like. Obviously, I cannot provide the exact details of the reform, or there would no point in having a process; the outcome would be preordained. The choice of a process is important, however, because the process will affect the outcome.

I first discuss how the process could work by drawing on the experience of the Shadow Open Market Committee (SOMC) founded in 1973 by Karl Brunner and Allan Meltzer. Second, I briefly review the case for monetary reform. Third, I propose some guiding principles for monetary reform. Fourth, I discuss the process in more detail.

The Shadow Open Market Committee

In August 1971, President Richard Nixon imposed wage-price controls in an attempt to dampen inflation, which was ninning at an annual rate of 4.4 percent (as reported at the time), as measured by the CPI. Arthur Burns, then chairman of the Federal Reserve, supported the controls to the dismay of Brunner and Meltzer, who, along with several other prominent economists, published an op-ed in the Wall Street Journal arguing that price controls distort market prices, and that the real cause of inflation is an excess growth of the money supply. But Meltzer (2000b: 2) recalled that although the oped attracted national attention, the process of getting the message out was "cumbersome, slow, and unsatisfactory." Thus, he and Brunner decided to establish the SOMC "to show that better policy choices were available and that inflation could be controlled at acceptable cost, if the Federal Reserve controlled money growth."

The SOMC met semi-annually over the years, and I attended several meetings as an observer in the mid- to late 1990s, when I worked in Washington, D.C. After Brunner's death in 1989, Meltzer alone chaired the group. Members of the SOMC prepared position papers on various aspects of monetary policy. The papers addressed both near-term policy and long-term issues. They were part of the process of improving policy discussion mentioned by Meltzer. A policy statement was prepared and committee members provided input into the statement's wording. The statement was modelled after that prepared at the meetings of the Federal Open Market Committee (FOMC). This all took place on a Sunday afternoon. The next day, the committee held a press conference.

The relevance of the SOMC to monetary reform today consists chiefly in its structure and focus. The membership of the committee did change gradually over time, but was relatively constant. There was continuity from meeting to meeting. Members certainly had different views on particular issues, and discussion was at times energetic. But all were committed to control of inflation through control of money growth. So there was a common purpose and broad agreement on theory. Consensus could be reached, typically driven by the chairman.

I propose incorporating these key features into a Committee for Monetary Reform. First, the committee must have a focus on fundamental monetary reform and not on current policy. Second, members should have a shared view of fundamental reform yet possess enough intellectual diversity to challenge each other on details. Third, discussions at meetings should build on prior discussions. The goal is to have a committee of semi-permanent membership and not a recurring seminar with an ever-changing set of participants. Meetings should take place on a regularly scheduled basis. Unlike the SOMC, the CMR should have a definite lifespan. Nothing facilitates agreement like a deadline.

Finally, and very importantly, there must a strong chairman to drive the committee to its goal. Anyone who has served on a committee, or been a senior staff member, can testify to the importance of a strong chairman.

Why Monetary Reform?

History does not repeat itself exactly. However, how leaders dealt with prior crises can provide lessons for dealing with new ones. The high inflation of the early 1970s generated a crisis of public policy: the imposition of wage-price controls. An ineffective, indeed, counterproductive economic policy was implemented to deal with a real problem. Meanwhile, the agency that could effectively control inflation was under a Fed chairman, Arthur Burns, who had an erroneous theory of inflation. (1) In Meltzer's account, the goal of forming the SOMC was to demonstrate that inflation could be controlled if the Federal Reserve controlled money growth.

Is there a crisis today? There is, in the sense that we are at a turning point for the Federal Reserve. There are multiple facets of the crisis.

Since the onset of the Great Recession and continuing into what is now more than six years of economic recovery and expansion, the Fed has greatly expanded its balance sheet and changed the composition of its assets. The average maturity of its portfolio has been lengthened, which means it has taken on much greater interest-rate risk, and its portfolio is concentrated in housing securities. Plosser (2014: 202) notes that this is a form of credit allocation that takes the central bank into the realm of fiscal policy, which deals with the size and composition of government spending. By lending to particular sectors at subsidized interest rates, the Fed is shifting resources toward favored sectors.

The Constitution intended that Congress make such decisions, if they are made at all, in a democratic fashion. Members are answerable to the electorate for their decisions. It is not always a pretty process to watch, but it imposes constraints not present when central bank policymakers make allocational decisions through the assets they purchase. If Congress wants to subsidize housing, the constitutional way to accomplish that goal is to appropriate funds for that purpose.

When a central bank strays into fiscal policy, it is at a minimum not a democratic process. It also threatens its independence and creates other political economy problems. As Plosser (2014: 208) emphasizes, "If the set of institutions having regular access to the Fed's credit facilities is expanded too far, it will create moral hazard and distort the market mechanism for allocating credit. This can end up undermining the very financial stability it is supposed to promote."

There is a crisis for the rule of law because the Fed is straying into fiscal policy. Thus, Plosser (2014: 208-09) advocates returning the Fed to a "Treasuries only" policy--that is, limit the central bank to purchasing only short-term T-bills--as an exit strategy from credit allocation. Other current and former Fed officials have made a similar recommendation (see, e.g., Lacker and Weinberg 2014). It is a proposal worthy of consideration by the proposed CMR.

The "Treasuries only" policy is not a panacea; it does not address the size of government, particularly its size relative to the private sector. It is government spending that takes resources away from the private sector, and thus...