Project 2025

[SunsetBengal]

Idk, Chapter 24 talking about reforms to the Federal Reserve System seem pretty sensible.

https://static.project2025.org/2025_MandateForLeadership_CHAPTER-24.pdf

Quote:FEDERAL RESERVE
Paul Winfree
Money is the essential unit of measure for the voluntary exchanges that
constitute the market economy. Stable money allows people to work
freely, helps businesses grow, facilitates investment, supports saving
for retirement, and ultimately provides for economic growth. The federal govern
ment has long made policy regarding the nation’s money on behalf of the people
through their elected representatives in Congress.1 Over time, however, Congress
has delegated that responsibility first to the Department of the Treasury and now
to the quasi-public Federal Reserve System.
The Federal Reserve was created by Congress in 1913 when most Americans lived
in rural areas and the largest industry was agriculture. The impetus was a series of
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inancial crises caused both by irresponsible banks and other financial institutions that
overextended credit and by poor regulations. The architects of the Federal Reserve
believed that a quasi-public clearinghouse acting as lender of last resort would reduce
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inancial instability and end severe recessions. However, the Great Depression of the
1930s was needlessly prolonged in part because of the Federal Reserve’s inept manage
ment of the money supply. More recessions followed in the post–World War II years.
In the decades since the Federal Reserve was created, there has been a down
turn roughly every five years. This monetary dysfunction is related in part to the
impossibility of fine-tuning the money supply in real time, as well as to the moral
hazard inherent in a political system that has demonstrated a history of bailing
out private firms when they engage in excess speculation.
Public control of money creation through the Federal Reserve System has
another major problem: Government can abuse this authority for its own advantage
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by printing money to finance its operations. This necessitated the original Federal
Reserve’s decentralization and political independence. Not long after the central
bank’s creation, however, monetary decision-making power was transferred away
from regional member banks and consolidated in the Board of Governors.
The Federal Reserve’s independence is presumably supported by its mandate
to maintain stable prices. Yet central bank independence is challenged in two addi
tional ways. First, like any other public institution, the Federal Reserve responds to
the potential for political oversight when faced with challenges.2 Consequently, its
independence in conducting monetary policy is more assured when the economy is
experiencing sustained growth and when there is low unemployment and price stabil
ity—but less so in a crisis.3 Additionally, political pressure has led the Federal Reserve
to use its power to regulate banks as a way to promote politically favorable initiatives
including those aligned with environmental, social, and governance (ESG) objectives.4
Even formal grants of power by Congress have not markedly improved Federal
Reserve actions. Congress gave the Federal Reserve greater regulatory authority
over banks after the stock market crash of 1929. During the Great Depression, the
Federal Reserve was given the power to set reserve requirements on banks and to
regulate loans for the purchase of securities. During the stagflation of the 1970s,
Congress expanded the Federal Reserve’s mandate to include “maximum employ
ment, stable prices, and moderate long-term interest rates.”5 In the wake of the
2008 global financial crisis, the Federal Reserve’s banking and financial regulatory
authorities were broadened even further. The Great Recession also led to innova
tions by the central bank such as additional large-scale asset purchases.
Together, these expansions have created significant risks associated with “too big
to fail” financial institutions and have facilitated government debt creation.6 Collec
tively, such developments have eroded the Federal Reserve’s economic neutrality.
In essence, because of its vastly expanded discretionary powers with respect
to monetary and regulatory policy, the Fed lacks both operational e ectiveness
and political independence. To protect the Federal Reserve’s independence and
to improve monetary policy outcomes, Congress should limit its mandate to the
sole objective of stable money.
This chapter provides a number of options aimed at achieving these goals along
with the costs and benefits of each policy recommendation. These recommended
reforms are divided into two parts: broad institutional changes and changes involv
ing the Federal Reserve’s management of the money supply.
BROAD RECOMMENDATIONS
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Eliminate the “dual mandate.” The Federal Reserve was originally
created to “furnish an elastic currency” and rediscount commercial paper
so that the supply of credit could increase along with the demand for money
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and bank credit. In the 1970s, the Federal Reserve’s mission was amended
to maintain macroeconomic stability following the abandonment of the
gold standard.7 This included making the Federal Reserve responsible for
maintaining full employment, stable prices, and long-term interest rates.
Supporters of this more expansive mandate claim that monetary policy
is needed to help the economy avoid or escape recessions. Hence, even if
there is a built-in bias toward inflation, that bias is worth it to avoid the
pain of economic stagnation. This accommodationist view is wrong. In fact,
that same easy money causes the clustering of failures that can lead to a
recession. In other words, the dual mandate may inadvertently contribute
to recessions rather than fixing them.
A far less harmful alternative is to focus the Federal Reserve on protecting
the dollar and restraining inflation. This can mitigate economic turmoil,
perhaps in conjunction with government spending. Fiscal policy can be
more e ective if it is timely, targeted, and temporary.8 An example from the
COVID-19 pandemic is the Paycheck Protection Program, which sustained
businesses far more e ectively than near-zero interest rates, which mainly
aided asset markets and housing prices. It is also worth noting that the
problem of the dual mandate may worsen with new pressure on the Federal
Reserve to include environmental or redistributionist “equity” goals in its
policymaking, which will likely enable additional federal spending.9
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Limit the Federal Reserve’s lender-of-last-resort function. To protect
banks that over lend during easy money episodes, the Federal Reserve
was assigned a “lender of last resort” (LOLR) function. This amounts
to a standing bailout o er and encourages banks and nonbank financial
institutions to engage in reckless lending or even speculation that both
exacerbates the boom-and-bust cycle and can lead to financial crises such as
those of 199210 and 200811 with ensuing bailouts.
This function should be limited so that banks and other financial
institutions behave more prudently, returning to their traditional role as
conservative lenders rather than taking risks that are too large and lead to
still another taxpayer bailout. Such a reform should be given plenty of lead
time so that banks can self-correct lending practices without disrupting a
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inancial system that has grown accustomed to such activities.
Wind down the Federal Reserve’s balance sheet. Until the 2008 crisis,
the Federal Reserve never held more than $1 trillion in assets, bought largely
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to influence monetary policy.12 Since then, these assets have exploded, and
the Federal Reserve now owns nearly $9 trillion of mainly federal debt
($5.5 trillion)13 and mortgage-backed securities ($2.6 trillion).14 There is
currently no government oversight of the types of assets that the Federal
Reserve purchases.
These purchases have two main e ects: They encourage federal deficits
and support politically favored markets, which include housing and even
corporate debt. Over half of COVID-era deficits were monetized in this way
by the Federal Reserve’s purchase of Treasuries, and housing costs were
driven to historic highs by the Federal Reserve’s purchase of mortgage
securities. Together, this policy subsidizes government debt, starving
business borrowing, while rewarding those who buy homes and certain
corporations at the expense of the wider public.
Federal Reserve balance sheet purchases should be limited by Congress,
and the Federal Reserve’s existing balance sheet should be wound down as
quickly as is prudent to levels similar to what existed historically before the
2008 global financial crisis.15
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Limit future balance sheet expansions to U.S. Treasuries. The Federal
Reserve should be prohibited from picking winners and losers among
asset classes. Above all, this means limiting Federal Reserve interventions
in the mortgage-backed securities market. It also means eliminating Fed
interventions in corporate and municipal debt markets.
Restricting the Fed’s open market operations to Treasuries has strong
economic support. The goal of monetary policy is to provide markets
with needed liquidity without inducing resource misallocations caused
by interfering with relative prices, including rates of return to securities.
However, Fed intervention in longer-term government debt, mortgage
backed securities, and corporate and municipal debt can distort the
pricing process. This more closely resembles credit allocation than
liquidity provision.
The Fed’s mortgage-related activities are a paradigmatic case of what
monetary policy should not do. Consider the e ects of monetary policy on
the housing market. Between February 2020 and August 2022, home prices
increased 42 percent.16 Residential property prices in the United States
adjusted for inflation are now 5.8 percent above the prior all-time record
levels of 2006.17 The home-price-to-median-income ratio is now 7.68, far
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above the prior record high of 7.0 set in 2005.18 The mortgage-payment-to
income ratio hit 43.3 percent in August 2022—breaking the highs of the prior
housing bubble in 2008.19 Mortgage payment on a median-priced home (with
a 20 percent down payment) jumped to $2,408 in the autumn of 2022 vs.
$1,404 just one year earlier as home prices continued to rise even as mortgage
rates more than doubled. Renters have not been spared: Median apartment
rental costs have jumped more than 24 percent since the start of 2021.20
Numerous cities experienced rent increases well in excess of 30 percent.
A primary driver of higher costs during the past three years has been the
Federal Reserve’s purchases of mortgage-backed securities (MBS). Since
March 2020, the Federal Reserve has driven down mortgage interest rates
and fueled a rise in housing costs by purchasing $1.3 trillion of MBSs from
Fannie Mae, Freddie Mac, and Ginnie Mae. The $2.7 trillion now owned by
the Federal Reserve is nearly double the levels of March 2020. The flood of
capital from the Federal Reserve into MBSs increased the amount of capital
available for real estate purchases while lower interest rates on mortgage
borrowing—driven down in part by the Federal Reserve’s MBS purchases—
induced and enabled borrowers to take on even larger loans.21 The Federal
Reserve should be precluded from any future purchases of MBSs and should
wind down its holdings either by selling o the assets or by allowing them to
mature without replacement.
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Stop paying interest on excess reserves. Under this policy, also started
during the 2008 financial crisis, the Federal Reserve e ectively prints
money and then “borrows” it back from banks rather than those banks’
lending money to the public. This amounts to a transfer to Wall Street at
the expense of the American public and has driven such excess reserves
to $3.1 trillion, up seventyfold since 2007.22 The Federal Reserve should
immediately end this practice and either sell o its balance sheet or simply
stop paying interest so that banks instead lend the money. Congress should
bring back the pre-2008 system, founded on open-market operations. This
minimizes the Fed’s power to engage in preferential credit allocation.
MONETARY RULE REFORM OPTIONS
While the above recommendations would reduce Federal Reserve manipulation
and subsidies, none would limit the inflationary and recessionary cycles caused by
the Federal Reserve. For that, major reform of the Federal Reserve’s core activity
of manipulating interest rates and money would be needed.
A core problem with government control of monetary policy is its exposure
to two unavoidable political pressures: pressure to print money to subsidize
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government deficits and pressure to print money to boost the economy artificially
until the next election. Because both will always exist with self-interested politi
cians, the only permanent remedy is to take the monetary steering wheel out of
the Federal Reserve’s hands and return it to the people.
This could be done by abolishing the federal role in money altogether, allowing
the use of commodity money, or embracing a strict monetary-policy rule to ward
o political meddling. Of course, neither free banking nor a allowing commodi
ty-backed money is currently being discussed, so we have formulated a menu of
reforms. Each option involves trade-o s between how e ectively it restrains the
Federal Reserve and how di cult each policy would be to implement, both polit
ically for Congress and economically in terms of disruption to existing financial
institutions. We present these options in decreasing order of e ectiveness against
inflation and boom-and-bust recessionary cycles.
Free Banking. In free banking, neither interest rates nor the supply of money
is controlled by the government. The Federal Reserve is e ectively abolished, and
the Department of the Treasury largely limits itself to handling the government’s
money. Regions of the U.S. actually had a similar system, known as the “Su olk
System,” from 1824 until the 1850s, and it minimized both inflation and economic
disruption while allowing lending to flourish.23
Under free banking, banks typically issue liabilities (for example, checking
accounts) denominated in dollars and backed by a valuable commodity. In the
19th century, this backing was commonly gold coins: Each dollar, for example, was
defined as about 1/20 of an ounce of gold, redeemable on demand at the issuing
bank. Today, we might expect most banks to back with gold, although some might
prefer to back their notes with another currency or even by equities or other assets
such as real estate. Competition would determine the right mix of assets in banks’
portfolios as backing for their liabilities.
As in the Su olk System, competition keeps banks from overprinting or lending
irresponsibly. This is because any bank that issues more paper than it has assets
available would be subject to competitor banks’ presenting its notes for redemp
tion. In the extreme, an overissuing bank could be liable to a bank run. Reckless
banks’ competitors have good incentives to police risk closely lest their own hold
ings of competitor dollars become worthless.24
In this way, free banking leads to stable and sound currencies and strong finan
cial systems because customers will avoid the riskier issuers, driving them out
of the market. As a result of this stability and lack of inflation inherent in fully
backed currencies, free banking could dramatically strengthen and increase both
the dominant role of America’s financial industry and the use of the U.S. dollar
as the global currency of choice.25 In fact, under free banking, the norm is for the
dollar’s purchasing power to rise gently over time, reflecting gains in economic
productivity. This “supply-side deflation” does not cause economic busts. In fact,
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by ensuring that cash earns a positive (inflation-adjusted) rate of return, it can pre
vent households and businesses from holding ine ciently small money balances.
Further benefits of free banking include dramatic reduction of economic cycles,
an end to indirect financing of federal spending, removal of the “lender of last
resort” permanent bailout function of central banks, and promotion of currency
competition.26 This allows Americans many more ways to protect their savings.
Because free banking implies that financial services and banking would be gov
erned by general business laws against, for example, fraud or misrepresentation,
crony regulatory burdens that hurt customers would be dramatically eased, and
innovation would be encouraged.
Potential downsides of free banking stem from its greatest benefit: It has mas
sive political hurdles to clear. Economic theory predicts and economic history
confirms that free banking is both stable and productive, but it is radically di erent
from the system we have now. Transitioning to free banking would require polit
ical authorities, including Congress and the President, to coordinate on multiple
reforms simultaneously. Getting any of them wrong could imbalance an otherwise
functional system. Ironically, it is the very strength of a true free banking system
that makes transitioning to one so di cult.
Commodity-Backed Money. For most of U.S. history, the dollar was defined in
terms of both gold and silver. The problem was that when the legal price di ered
from the market price, the artificially undervalued currency would disappear from
circulation. There were times, for instance, when this mechanism put the U.S. on
a de facto silver standard. However, as a result, inflation was limited.
Given this track record, restoring a gold standard retains some appeal among
monetary reformers who do not wish to go so far as abolishing the Federal Reserve.
Both the 2012 and 2016 GOP platforms urged the establishment of a commis
sion to consider the feasibility of a return to the gold standard,27 and in October
2022, Representative Alexander Mooney (R–WV) introduced a bill to restore the
gold standard.28
In economic e ect, commodity-backing the dollar di ers from free banking in
that the government (via the Fed) maintains both regulatory and bailout functions.
However, manipulation of money and credit is limited because new dollars are not
costless to the federal government: They must be backed by some hard asset like
gold. Compared to free banking, then, the benefits of commodity-backed money
are reduced, but transition disruptions are also smaller.
The process of commodity backing is very straightforward: Treasury could
set the price of a dollar at today’s market price of $2,000 per ounce of gold. This
means that each Federal Reserve note could be redeemed at the Federal Reserve
and exchanged for 1/2000 ounce of gold—about $80, for example, for a gold coin the
weight of a dime. Private bank liabilities would be redeemable upon their issuers.
Banks could send those traded-in dollars to the Treasury for gold to replenish their
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vaults. This creates a powerful self-policing mechanism: If the federal govern
ment creates dollars too quickly, more people will doubt the peg and turn in their
gold to banks, which then will turn in their gold and drain the government’s gold.
This forces governments to rein in spending and inflation lest their gold reserves
become depleted.
One concern raised against commodity backing is that there is not enough gold
in the federal government for all the dollars in existence. This is solved by making
sure that the initial peg on gold is correct. Also, in reality, a very small number of
users trade for gold as long as they believe the government will stick to the price
peg. The mere fact that people could exchange dollars for gold is what acts as the
enforcer. After all, if one is confident that a dollar will still be worth 1/2000 ounce
of gold in a year, it is much easier to walk about with paper dollars and use credit
cards than it is to mail tiny $80 coins. People would redeem en masse only if they
feared the government would not be able control itself, for which the only solution
is for the government to control itself.
Beyond full backing, alternate paths to gold backing might involve gold-con
vertible Treasury instruments29 or allowing a parallel gold standard to operate
temporarily alongside the current fiat dollar.30 These could ease adoption while
minimizing disruption, but they should be temporary so that we can quickly enjoy
the benefits of gold’s ability to police government spending. In addition, Congress
could simply allow individuals to use commodity-backed money without fully
replacing the current system.
Among downsides to a commodity standard, there is no guarantee that the gov
ernment will stick to the price peg. Also, allowing a commodity standard to operate
along with a fiat dollar opens both up for a speculative attack. Another downside is
that even under a commodity standard, the Federal Reserve can still influence the
economy via interest rate or other interventions. Therefore, at best, a commodity
standard is not a full solution to returning to free banking. We have good reasons
to worry that central banks and the gold standard are fundamentally incompati
ble—as the disastrous experience of the Western nations on their “managed gold
standards” between World War I and World War II showed.
K-Percent Rule. Under this rule, proposed by Milton Friedman in 1960,31 the
Federal Reserve would create money at a fixed rate—say 3 percent per year. By
o ering the inflation benefits of gold without the potential disruption to the finan
cial system, a K-Percent Rule could be a more politically viable alternative to gold.
The principal flaw is that unlike commodities, a K-Percent Rule is not fixed
by physical costs: It could change according to political pressures or random
economic fluctuations. Importantly, financial innovation could destabilize the
market’s demand for liquidity, as happened with changes in consumer credit pat
terns in the 1970s. When this happens, a given K-Percent Rule that previously
delivered stability could become destabilizing. In addition, monetary policy when
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Friedman proposed the K-Percent Rule was very di erent from monetary policy
today. Adopting a K-Percent Rule would require considering what transitions need
to take place.
Inflation-Targeting Rules. Inflation targeting is the current de facto Federal
Reserve rule.32 Under inflation targeting, the Federal Reserve chooses a target infla
tion rate—essentially the highest it thinks the public will accept—and then tries
to engineer the money supply to achieve that goal. Chairman Jerome Powell and
others before him have used 2 percent as their target inflation rate, although some
are now floating 3 percent or 4 percent.33 The result can be boom-and-bust cycles
of inflation and recession driven by disruptive policy manipulations both because
the Federal Reserve is liable to political pressure and because making economic
predictions is very di cult if not impossible.
Inflation and Growth–Targeting Rules. Inflation and growth targeting is a
popular proposal for reforming the Federal Reserve. Two of the most prominent
versions of inflation and growth targeting are a Taylor Rule and Nominal GDP
(NGDP) Targeting. Both o er similar costs and benefits.
Economists generally believe that the economy’s long-term real growth trend
is determined by non-monetary factors. The Fed’s job is to minimize fluctuations
around that trend nominal growth rate. Speculative booms and destructive busts
caused by swings in total spending should be avoided. NGDP targeting stabilizes
total nominal spending directly. The Taylor Rule does so indirectly, operating
through the federal funds rate.
NGDP targeting keeps total nominal spending growth on a steady path. If the
demand for money (liquidity) rises, the Fed meets it by increasing the money
supply; if the demand for money falls, the Fed responds by reducing the money
supply. This minimizes the e ects of demand shocks on the economy. For example,
if the long-run growth rate of the U.S. economy is 3 percent and the Fed has a 5 per
cent NGDP growth target, it expands the money supply enough to boost nominal
income by 5 percent each year, which translates into 3 percent real growth and 2
percent inflation. How much money must be created each year depends on how
fast money demand is growing.
The Taylor Rule works similarly. It says the Fed should raise its policy rate
when inflation and real output growth are above trend and lower its policy rate
when inflation and real output growth are below trend. Whereas NGDP targeting
focuses directly on stable demand as an outcome, the Taylor Rule focuses on the
Fed’s more reliable policy levers.
The problem with both rules is the knowledge burden they place on central
bankers. These rules state that the Fed should neutralize demand shocks but
not respond to supply shocks, which means that it should “see through” demand
shocks by tolerating higher (or lower) inflation. In theory, this has much to recom
mend it. In practice, it can be very di cult to distinguish between demand-side
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destabilization and supply-side destabilization in real time. There also are political
considerations: Fed o cials may not be willing to curb unjustified economic booms
and all too willing to suppress necessary economic restructuring following a bust.
Either rule likely outperforms a strict inflation target and greatly outperforms
the Fed’s current pseudo-inflation target. While NGDP targeting and the Taylor
Rule have much to commend them, they might be harder to explain and justify to
the public. Inflation targeting has an intelligibility advantage: Voters know what
it means to stabilize the dollar’s purchasing power. Capable elected o cials must
persuade the public that the advantages of NGDP targeting and the Taylor Rule,
especially in terms of supporting labor markets, outweigh the disadvantages.
MINIMUM EFFECTIVE REFORMS
Because Washington operates on two-year election cycles, any monetary reform
must take account of disruption to financial markets and the economy at large.
Free banking and commodity-backed money o er economic benefits by limiting
government manipulation, inflation, and recessionary cycles while dramatically
reducing federal deficits, but given potential disruption to the financial system, a
K-Percent Rule may be a more feasible option. The other rules discussed (infla
tion targeting, NGDP targeting, and the Taylor Rule) are more complicated but
also more flexible. While their economic benefits are significant, public opinion
expressed through the lawmaking process in the Constitution should ultimately
determine the monetary-institutional order in a free society.
The minimum of e ective reforms includes the following:
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Eliminate “full employment” from the Fed’s mandate, requiring it to
focus on price stability alone.
Have elected o cials compel the Fed to specify its target range for
inflation and inform the public of a concrete intended growth path.
There should be no more “flexible average inflation targeting,” which
amounts to ex post justification for bad policy.
Focus any regulatory activities on maintaining bank capital
adequacy. Elected o cials must clamp down on the Fed’s incorporation of
environmental, social, and governance factors into its mandate, including by
amending its financial stability mandate.
Curb the Fed’s excessive last-resort lending practices. These practices
are directly responsible for “too big to fail” and the institutionalization of
moral hazard in our financial system.
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Appoint a commission to explore the mission of the Federal Reserve,
alternatives to the Federal Reserve system, and the nation’s financial
regulatory apparatus.
Prevent the institution of a central bank digital currency (CBDC). A
CBDC would provide unprecedented surveillance and potential control of
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inancial transactions without providing added benefits available through
existing technologies.3