On Rhetoric, Civic life, Gender, and Cynicism

To Intervene or not to Intervene

Readers always leave insightful comments, but one reader last week left a comment including a particularly interesting question, which I feel is so important I will dedicate this week’s post to answering it. He stated that from the knowledge acquired in a microeconomics class he was taught or persuaded that free-market approaches to the economy led to stability and was therefore more desirable while government intervention was undesirable and “bad.” ┬áThe reader wondered if this was an idea taught in microeconomic courses but not necessarily in macroeconomic classes. This question is not a macro versus micro argument, but rather, an age-old question economists, politicians, and laymen have been arguing. Actually, it’s not an age-old question. It’s something that has been debated since the Great Depression when it was widely believed the Great Depression was the result of free-market failures (if you ask me or Chairman Bernanke, by the way, we’d have to say that this belief is entirely unmerited).

To intervene or not to intervene in the market has divided economic thought for almost a century. Now, I personally do favor a hands-off approach to markets and its characters (interest rates, supply, demand, housing prices, et cetera), but this blog is intended to analyze the Fed’s policy. The Fed’s job is to intervene in the market to stabilize the money supply, and I’m not going to make this a blog about how the Fed is doing everything wrong. Man has a tendency to attempt to control things that may be uncontrollable, and so it’s inevitable that he will attempt to control the economy, regardless of whether he can do so successfully. If we are to have intervention in the money supply, we may as well have it under the nonpartisan Federal Reserve. The Fed has a massive influence on interest rates, which I’ve discusses before. The market can set its own interest rates, of course, by simply having the supply and the demand set the price of burrowing money (which is essentially what interest rates are). However, when an economy is sluggish like it is now, an increase in investment spending, such as when businesses get money from banks to increase their business operations, can help increase output and GDP (which is good). Businesses are more likely to do this if interest rates are low because the cost of them borrowing money is less. Lower interest rates equate to businesses having less to payback to the banks. Essentially, low interest rates can help economic growth, so Fed intervention can be helpful here.

In the American economy, as well is in all post-industrial and most industrial economies, money only has value because the government says it has value. This is called fiat money, which is opposed to commodity-backed money like the gold or silver standards. Expecting an economy to correctly inflate and deflate on its own under a fiat system is like expect a four year old to clean up his own room without being told to do so. It’s not going to happen. The Fed injects money into the economy regularly at a rate that is relatively equal to the increase in economic output (GDP). This way, there is enough money to buy all the goods and services in an economy, and we have a nice equilibrium, where inflation does not occur. The Fed and its intervention is thus vital to our economy.

Many politicians and economists, particularly those on the political far-right wish to abolish the Fed. Some even want to return to the gold or silver standard. This would be a disaster (England tried returning during the Great Depression, and in case you didn’t know, it went terribly). In a picture-perfect world where Adam Smith’s laissez-faire market was implemented, minimal or nonexistent government intervention might work, but it simply isn’t realistic in today’s economy that is changing rapidly and that may be more volatile than it used to be. Whether governments should intervene in an economy is a debate I will leave to philosophical economists who never leave the classroom. I’m more interested in to what extent and in what particularly manners should the government, but particularly the Fed, intervene in the market. Clearly, I hold that the Fed has the duty to hold down interest rates when economic growth is slow, but whether it should alter this policy when the growth picks up or how much it should regulate the banking industry (these are some of its other roles) are topics for later posts.

2 Comments

  1. Brian Gross says:

    From my limited knowledge (and I use the term “knowledge” loosely) of economics, intervention by the Fed seems like the way to go. Of course, it is way more complicated than I can imagine, but lowering interest rates seems like a good way of stimulating money flow and increasing consumption in turn. I didn’t know it was the Fed’s job to regulate interest rates like this, so thanks for informing me. I can definitely say this blog teaches me something new every week. Great job!

  2. Dylan Humenik says:

    Thanks for clearing that up! Your post last week makes more sense now and as a result I’m more knowledgeable about the Fed. Your posts are always full of information, and I can’t wait to hear more. Do you have a background in this kind of stuff? You sure write like you do.

Leave a Reply

You must be logged in to post a comment.

Skip to toolbar