Through his recent appointments, President Donald Trump has begun a much-needed conversation at and about the Federal Reserve. Fundamentally, the president is asking: Does the current Fed truly believe growth causes inflation?
We also have learned that Trump wants to fill the other Fed board vacancy with Herman Cain—a former presidential candidate who supported tax reform in his 2012 run and very successful businessman who was the CEO of Godfather’s Pizza for 10 years.
Those nominations serve notice that Trump agrees with Moore that the Fed is a threat to economic growth. They also note that Trump wants a change of policy direction at the Fed.
The heart of the issue is the Fed’s governance by the Phillips curve.
It’s an outdated notion that an “overheated” economy leads to inflation. Put another way, according to author Brian Domitrovic, economist and chairman of the history department of Sam Houston State University, “If inflation goes up, unemployment must go down and if unemployment goes up, then inflation must go down.”
The Phillips curve, and, therefore, the current Fed board, stands in contradiction to basic economics and the history of capitalism. Consider these words by historians Will and Ariel Durant:
“The capitalist, of course, has fulfilled a creative function in history: he has gathered the savings of the people into productive capital by the promise of dividends or interest; he has financed the mechanization of industry and agriculture, and the rationalization of distribution; and the result has been such a flow of goods from producer to consumer as history has never seen before.”
What is the effect on prices of the production of more goods and services? In our own time, we have seen the result.
Consider the consumer electronics industry. From radios in the 1920s to televisions, to computers, and now cell phones, the industry has exploded to more than $3 trillion worldwide and $1.7 trillion in the United States. That latter number is no small amount. It represents more than 11 percent of the U.S. economy, and the size of the U.S. consumer electronics market is expected to grow more than 6 percent in the coming year.
According to the Fed’s view of the economy, economic growth above 3 percent leads to increases in the Consumer Price Index. Perhaps they would prefer the growth in the consumer electronics market to be no more than 3 percent. Or perhaps they like growth in that sector of the economy, but want less growth elsewhere.
Wouldn’t that amount to central planning by the Fed?
We shouldn’t be surprised by that result. Falling prices are the norm in capitalist systems, thanks to investment pushing down the prices of most everything. It’s consistent with one of the most basic notions of economics, i.e., supply and demand—an increase in supply exerts a downward pressure on prices. Indeed, a recent study showed that airfare to Hawaii from California has dropped 17 percent since Southwest began flying to Hawaii.
Let’s continue. Computer prices fell more than 90 percent from 1998 to 2009 alone. The computer revolution is important because it has led to increased productivity that, on its own, exerts downward pressure on prices.
Returning to current Fed policy, Domitrovic said, “By my count, there have been seven Nobel prizes awarded for economists that have disproven the Phillips curve.”
All of the above raises the question: Why does the Fed continue to allow the discredited Phillips curve to govern its actions? That Fed officials believe prosperity has a downside, and believe this without much pushback, is all the evidence we need that Cain and Moore would be nice additions to an entity that is less effective precisely because there’s so very little dissent.
