"It is the sense of the Congress that monetary policy and the economic assumptions in the budget resolution shall be consistent with each other."
Some fear that that one sentence, buried in the body of the budget resolution recently passed by the House of Representatives, will radically change the formulation of monetary policy in this country. Others hope that it will.
At first sight, the sentence hardly looks controversial. How could a country possibly devise a budget strategy without knowing what its monetary policy will be? It also seems absurd to allow an unelected board of governors of the Federal Reserve System choose goals independent of the goals set by our elected representatives.
But we do such things, and many think it an odd way to plan monetary and fiscal policies. However, anomalies often exist for good reasons. Cures can be worse than the disease.
In this instance, the disease may not be as serious as it first appears. Much is made of the independence of the Fed. But it certainly reads election results as carefully as they are read by the Supreme Court. It cannot deviate far from the goals set by the body politic without creating unpleasant political conflicts that would be unsettling to financial markets and, hence, to the economy as a whole.
Moreover, any procedural attempt to make Fed goals more explicit confronts a host of problems. Our goals and policies are the result of a complex tug of war between the president and Congress. If the two branches of government disagree on the feasibility of various goals, how is the Fed to choose between them without souring its relations with one or the other? Some disagreements are better left ambiguous.
There is also a tendency to ascribe more power to the Fed than it actually has. It can, through its control over the money supply, influence the rate of growth of the money value of the gross national product, but its influence on the way that growth is divided between real growth and inflation is much more indirect and uncertain. It can lower interest rates in the very short run, but only by increasing bank reserves. A persistent attempt to keep rates artificially low will eventually cause inflation and, before that, expectations of inflation. Inexorable upward pressure is then placed on interest rates and, ultimately, the Fed has no choice but to surrender. Attempts to force it to pursue unrealistic goals can thus be highly destabilizing and, therefore, dangerous.
Despite such serious problems, it is easy to sympathize with the House as it tries to exert more control over monetary policy. The Fed, at this critical moment in our economic history, is vague about its goals and techniques. If we do not know what it is trying to do, then we won't know whether it is doing a good or bad job. If its competence cannot be judged, its credibility, recently won in its long-run fight against inflation, will be difficult to retain.
Many of us believe that the current state of economic knowledge is too dismal to allow fine- tuning of the economy. Time lags between policy changes and economic results are long and highly uncertain. Impatient politicians often demand another dose of stimulus or constraint before we know how the last dose worked. As a result, activist policies tend to be destabilizing on balance. Under these conditions, the best chance for economic stability lies in stable monetary policies constrained by rules that limit variations in the rate of money growth.
Obvious and dramatic changes in the structure of the economy may from time to time warrant a change in the rules. The Fed suggests that this is such a time. It is alleged that changes in financial regulation and the fall in inflation have fundamentally altered the relationship between various measures of the money supply and the amount of economic activity. This argument has been used to rationalize the explosion in various measures of the money supply occurring since last summer. But while some change in the rules may have been justified, how do we know whether it should have been so large? What is the Fed using for scientific evidence? What is the desired growth rate for the money value of GNP in the short and long run?
Because such questions have not been answered satisfactorily, I take some pleasure in the House's passing a plea for more information. By expressing its concern, it may induce the Fed to be somewhat more open about its goals and techniques. But I rather hope that the Sente does not pass a similar plea and that the whole thing dies in conference. We have not yet thought carefully enough about the practical difficulties of implementing such a resolution and about the many problems that it may create. Informally pressuring the Fed to be more open and explicit is not a bad idea. Formalizing a procedure for doing so may be self-destructive.