There’s been some good commentary from Brad Delong and Paul Krugman in the last few days on the way many people view the role of the central bank. The views tend to fall on one side of a fairly distinct line. Dr Krugman explains:
“Brad DeLong has an excellent piece distinguishing between two views of central banking. There’s the “banking camp,” which sees the central bank’s job as being to secure the stability of the financial system – full stop. OK, maybe also price stability. And then there’s the “macroeconomics camp,” which sees the central bank’s job as being to achieve full employment; banking stability and even price stability are basically means towards that end.”
I believe both views are basically right, but I think it’s important to understand the institutional design of the Fed in order to view this distinction properly. The Fed is basically a big bank with some special government granted powers. And this big special bank works its policies THROUGH the private banking system. So, when the banking system doesn’t work the Fed is kind of broken. And that means that the Fed has to keep the banks working smoothly if it can work smoothly. Despite the Fed’s dual mandate, you get a weird sort of hierarchy of importance with the Fed where it’s a creature of Congress and is responsible to hitting its dual mandate, but can only really do so by hitting its primary mandate which is keeping the banking system working smoothly. In other words, I like to say that the Fed serves two masters – the private banking system and the US taxpayer, but it serves the banking system first by necessity.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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