Economic Calculation Under the Fed

By: Robert Aro

When the Federal Reserve or Government intervenes in our lives and the free market, it’s normally referred to as “central planning” or “economic planning.” However, whenever a handful of handsomely compensated people make economic decisions on behalf of the citizens, economic calculation is impossible. But without economic calculation, how are decisions made?

Last Thursday, Federal Reserve Bank of Philadelphia President Patrick Harker gave an interview to the Wall Street Journal, illustrating the thought process for “tapering” the Fed’s balance sheet:

We’re talking about a process that once we start it, depending on how we do it, would be, say, 12 months in length… We’re doing $120 billion a month, if we cut back $10 billion each month, we’d be done in 12 months, right? I think that’s a reasonable thing to do.

He’s referring to the $8 trillion balance sheet which the Fed has been steadily increasing by purchasing approximately $120 billion worth of US and Mortgage Debt over the past year.

Interestingly, this tapering doesn’t refer to actually shrinking the balance sheet from its current all time high. Instead, the goal is to decrease the number of new purchases by a smaller amount on a month over month basis.

Under his plan, one year later the Fed would add approximately $760 billion new securities. If the Fed continued its $120 billion monthly purchase for an entire year, the result would be approximately $1.4 trillion in new securities purchased in the year. It hasn’t been stated what happens after the one-year mark is reached.

While true, $760 billion is less than $1.4 trillion, the takeaway is the method in which these planners use to arrive at these billion-dollar ideas. The first issue is the rationale behind $120 billion per month payments by the Fed has never been explained. Other than telling the public that this money will add liquidity to the market, no one has ever made the case as to how the purchase amount was arrived. They could have bought $60 billion a month, or $200 billion a month. Either way, there exists no measurement or calculation to say $120 billion per month is the correct or even “optimal” number of securities to purchase.

Over a year later, the Fed recognizes they should not baselessly increase the money supply indefinitely; therefore, talk of tapering begins. But the second issue is just as impossible to answer as the first: if the Fed is to buy less securities, then by how much and how quickly should this be done?

They could simply stop making purchases over night, or use the President’s proposed plan of a slow reduction in purchases, despite no one being able to explain why $10 billion a month is preferred to $20 or $30 trillion. All methods are equally valid as they are based on nothing more than the whimsical nature of the central planner; thus, all decisions of the planner remain, in effect, “right.” Until central planners are removed, society will have no other choice but to live under the market conditions the planners believe best suited for us.

We are sadly reminded that a handful of experts have the power to make billion-dollar decisions based on nothing more than guesswork or a gut feeling at best, or for self-serving and possibly nefarious means at the very worst. In the case of the Fed’s tapering, according to the President, there need not be any basis other than the belief that it seems like a “a reasonable thing to do,” right?

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