Blame Congress for Inflation
By PAUL D. RYAN
Yesterday, the Federal Reserve lowered the fed-funds rate to 2%, its lowest level since late 2004. In a nod to growing inflation fears, the Fed said "it will be necessary to continue to monitor inflation developments carefully."
But if we really want to do something about inflation, Congress should repeal the Humphrey-Hawkins Full Employment Act of 1978, which dangerously diverted the Fed from its most important job: price stability. When the Fed was created in 1913, its principal role was to maintain a sound currency with stable prices. But Humphrey-Hawkins changed the Fed's mandate, directing it to focus on long-term price stability and short-term economic growth.
Unfortunately, in its efforts to accomplish both, the Fed could end up satisfying neither. This would make the next 18 to 24 months even more painful, as the Fed reverses course and sharply raises rates to wring inflation out of the economy. These Fed-induced boom and bust cycles are detrimental to our long-term economic growth and living standards.
Because goosing the economy in the short run and maintaining stable prices over the long haul are often at odds, I'm introducing legislation that would rewrite Humphrey Hawkins and give the Fed just one mandate: price stability. The bill, called the Price Stability Act of 2008, allows the Fed to choose how it will put this single mandate into practice (my preference would be an explicit price rule anchored to a basket of commodities), as long as its overriding policy goal is to control inflation.
An explicit commitment to price stability – which Fed Chairman Ben Bernanke has endorsed in the past – would have a number of benefits. It would protect the Fed against political pressure to be the "savior" of the economy. It would strengthen the dollar, because it would be a clear indication that our central bank (the world's de-facto central bank) is committed to sound money. It would also help anchor the public's inflation expectations, which have recently shown signs of creeping upward. That alone could reduce the amount of monetary tightening needed later on.
Price stability is a basic necessity of long-term prosperity. And, with monetary policy under its jurisdiction, the Fed is the only institution capable of stabilizing prices. But its recent, repeated reductions in the federal funds target rate – down from 5.25% in September – were intended to ameliorate the short-term slump. This threatens to unleash inflationary problems that could hamper the economy for a very long time.
The Fed's actions have pushed real short-term interest rates into negative territory. This has accelerated the decline of the dollar, and helped drive up the price on a broad range of commodities as global investors flee the greenback for hard assets.
Crude oil prices have doubled over the past year to nearly $120 a barrel, while average retail gasoline prices hit an all-time high of $3.60 per gallon this week. The prices of basic food items are also soaring: Figures from the Department of Agriculture show that the monthly grocery bill for the average American family is $70 higher today than one year ago.
Lower interest rates have also reduced the yield on safe investments such as money market funds and CDs, providing a double whammy for seniors. Capital investment is bound to suffer in an inflationary environment, as long-term planning becomes difficult and the effective tax rate on capital increases (because capital gains taxes are not indexed for inflation).
Clearly, these negative outcomes are not the intention of Fed policy. Mr. Bernanke has been dealt a bad hand – a slowing economy and upward pressure on prices – and he is trying to win on both ends. But Congress, too, is accountable in this – because it set the Fed's mandate.
Congress is already threatening the economic climate by dangling the prospect of huge tax increases ($683 billion in the House-passed budget) and sharply higher spending. There is no sign that Congress will change its tune on fiscal affairs – but passing the Price Stability Act is a chance at a bipartisan commitment to sound money.
By refocusing the Federal Reserve's legal mandate, Congress can strengthen the economy and do so without incurring any cost to the budget or increasing the deficit.
Mr. Ryan (R., Wis.) is a member of the Budget and Ways & Means committees.