Most economists argue that the Fed should either cut rates or raise them. Wayne Jett, chief economist at Classical Capital thinks the answer is “neither.” Jett argues that the Fed should just float the rate and allow market mechanisms to determine the price of credit:
The FOMC should cut the funds rate to 1% or, much better, float the rate and allow the markets to set the cost of credit. Economic growth and the dollar would be far better off for having markets rather than central planners making such decisions.
What about the weak dollar and soaring inflation? Wouldn’t a relaxed policy lead to a run on the dollar and double-digit CPI increases? No, according to Jett. Interest rates only effect currency prices at the margin:
The strength of the dollar may be affected on the margin by currency speculators who choose to “park” in one place or another. But the dollar’s fundamental strength is determined by demand for it as a unit of account and store of value in commercial transactions. Trust and confidence in any currency requires that its value remain stable at all times and over the long term. Stability of currency value requires a mechanism that adjusts liquidity according to changing conditions affecting demand; i.e., market willingness to invest in production.
Jett may be right about markets being a more efficent mechanism to set rates than central planners, but his arguments about currency values are weak. The Fed controls the supply of currency by manipulating the fed funds rate. Like anything else, the price of the dollar is determined by supply and demand. If supply contracts, all things being equal, price will increase. This doesn’t just affect the price “on the margin,” as Jett claims, it effects the price period. Jett goes on to suggest that the Fed should index the dollar to the price of Gold:
Supply and demand for currency determines its value. This truism combined with the fact that gold has essentially unchanging intrinsic value enables a central bank (if it chooses) to manage liquidity (supply) according to changes in demand so as to keep the currency value stable. Stated simply, the central bank can keep supply in balance with demand by watching its currency’s price of gold and keeping that price stable.
This seems like a more complicated way of doing the same thing. Gold doesn’t have an unchanged “intrinsic” value any more than a dollar or euro does. Its price is determined by, you guessed it, supply and demand. People will demand more or less of it depending on its perceived value, which like other commodities, can swing drastically. And the only tool the Fed can use to tweak the dollar’s price to match gold is rate manipulation.
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