Friedman on the Fed: too little control over too much money
The money supply is running around loose, says Dr. Milton Friedman, while the Federal Reserve Board chases after it -- unwilling or unable to take the steps necessary to rein in the runaway dollars.
At a breakfast meeting with reporters, the ebullient economist said he would give the Fed an "F" for its recent efforts, and that for operational purposes the board should be made part of the Treasury Department.
"Money is too important to leave to central bankers," he said, adding that over the last 30 years even Congress would have done a better job of setting monetary policy than the Federal Reserve.
Later that same day, there were indications in the money markets that Mr. Volker and company were in effect following Dr. Friedman's admonition to tighten the supply of money to the economy. It permitted the federal funds rate -- the interest that banks charge in making overnight loans to one another -- to rise above 20 percent. Some top bank economists speculated that the prime rate, the interest banks charge their best customers, would puncture "in short order" the 21.5 percent record set last year.
Fed chairman Paul a. Volcker and his board of governors have the right goals, said Dr. Friedman, but such events as the surprising $4.2 billion surge in the most closely watched measure of the money supply, M1-B, during the last week in April show they're still not getting the right results.
"It must be that he [Volcker] doesn't run the system. You have a large bureaucracy that runs itself," said Friedman.
Federal Reserve vice-chairman Frederick Schultz reacted "very negatively" to Mr. Friedman's proposal to put the Fed under the aegis of the US Treasury.
"Dr. Friedman is a very able man," Mr. Schultz said, "but he clearly has not thought through the implications of such a suggestion."
Schultz said the idea of an independent central bank was based on the need to remove monetary policy from the pressure of partisan politics. If the Fed was led into the fold of executive agencies "no administration could possibly withstand the urge to manipulate the money supply for political purposes."
Monetary policy affects each American citizen's personal money supply, counters Rep. Fernand St. Germain (D) of Rhode Island, chairman of the House Banking, Finance, and Urban Affairs Committee. "The independence of the Fed is all well and good, but if monetary policy is not working properly the electorate becomes upset with elected officials."
Mr. St. Germain agrees with Friedman that there should be more political constraints on the direction of monetary policy. He believes that any effort to use the Fed as a political toy would be halted by a backlash of public opinion. The White House already has much behind-the-scenes influence on what the Fed does. Monetary policy has shifted to fit the preferences of our last five presidents.
"We probably ought to bring out into the open what is now done somewhat under the table," says Robert Weintraub, an economist for the Joint Economic Committee.
The Fed now is required to report to Congress on its activities. Rep. Henry Reuss (D) of Wisconsin, chairman of the Joint Economic Committee, says he thinks the relationship between Capitol Hill and the Fed is "about right," adding that "I wouldn't want the Treasury or the administration, in effect, to take over the Fed."
Friedman contends that a succession of chairmen, all able and respected men, have taken charge of the Fed, yet have been unable to steady an erratic and inflationary policy.
"The fundamental problem is a stubborn resistance to changes in operating procedures that 90 percent of the technical economists in this area think they should make," said Friedman.
He listed some specific recommendations:
* Currently, the amount of money a bank has to keep on hand (reserve requirements) depends on what its total deposits were two weeks earlier. Dr. Friedman would eliminate the two-week lag.
* Banks now settle their reserve requirements on Wednesday. By staggering these settlement periods, the midweek crush could be avoided.
* The Fed's discount rate could be directly linked to a market rate, such as 90-day Treasury bills.
* The reserve requirements for different financial institutions could be made as equal as possible.
* The Fed should announce in advance, using dollar figures, what its moves for an upcoming time period would be.
Lately, there has been some speculation that Dr. Friedman would be named to the Fed's board of governors, perhaps as a replacement for Volcker. Friedma n claims, "I have no desire to move to Washington."