What Happens If We End the Fed?

US News

The "End the Fed" movement appears to have a lot going for it these days. Its adherents now include both conservatives and supporters of the Occupy movement. Perhaps its most prominent proponent, Rep. Ron Paul, has garnered respectable poll numbers in the 2012 Republican presidential race and blasts the Federal Reserve at every opportunity. Plus, the succinct slogan fits well on protest signs.

Removing the institution at the helm of U.S. monetary policy since 1913 seems unrealistic, though, and opponents consider it a crazy idea, even dangerous. However, proponents keep up the call, using an array of arguments from economic theory to promoting liberty.

Whatever view one takes, ending the Fed is a goal much more easily stated than accomplished. But if Fed bashers got their wish, here are a few snapshots of how the country might change:

[Read analysis of the Fed's latest Beige Book report.]

A New Monetary Standard

Many advocates of ending the Fed argue for a return to the gold standard, which President Nixon ended in 1971, due in part to growing inflation, which was itself due to the costs of the Vietnam War. In addition, Nixon was concerned that Fort Knox contained only one third of the gold needed to back the dollars in foreign hands at that time. Under this system, the dollar's value would once again be tied to the price of gold. Another option is to tie the U.S. dollar's value to a basket of commodities.

End to Constant Inflation (for better or worse)

Tying the dollar's value to a commodity could very well moderate inflation. If the country moved to a strict gold standard, for example, the money supply would be bound to the supply of gold, so printing more dollars would require acquiring more bullion to back them, a big disincentive. This notion, of course, pleases proponents of controlled government spending. Though there might be short-term bouts of inflation and deflation, in the long run, prices could easily remain stable. There are, of course, caveats. For example, massive borrowing could spark inflation. And the country would also be forced to periodically deal with the relatively unfamiliar territory of deflation. Returning to the gold standard in particular could make these problems worse. "The gold market can have very large movements within a day," says Randall Kroszner, an economics professor at the Booth School of Business at the University of Chicago and a former governor of the Federal Reserve System. He adds that during recent times of economic uncertainty, this added volatility would likely not have been helpful.

Shock to the System

A change to the U.S. currency system could potentially be destabilizing to foreign economies. Kroszner says that, as many countries tie their currencies' values to the dollar, the potential deflationary effects of being linked to a gold standard would lead to more exchange-rate volatility. But advocates say the result would be more long-term stability for the global economic system. "I think it would be extremely positive, but the initial effect would be so bold as to be alarming," says Judy Shelton, a senior fellow at the Atlas Economic Research Foundation, a nonprofit organization that advocates for free markets.

A Sad Day for Keynesians

Most Keynesian economists believe that expansionary monetary policy moves can boost economic growth. The U.S. has seen this at work most notably with the latest round of quantitative easing, known as QE2. The effectiveness of quantitative easing, especially balanced with associated inflation risks, have been hotly debated in recent years. But no more Fed would simply mean no more easing programs.

Saving May Be More Attractive

Shelton argues that the Fed, with its near-zero interest rates and contributions toward dollar devaluation, "makes a sucker out of a saver." "You save money, you've got zero interest for saving it, and by the time you get it back out, it's worth less," she says. Without the Fed pushing interest rates low in hopes of stimulating the economy, says Shelton, saving money could be much more rewarding.

Ending the Business Cycle

This is how Ron Paul put it in his 2009 book, End the Fed. According to Paul and the Austrian school of economics, the booms, bubbles, and busts of business cycles are the result of meddling by central banks. But Shelton moderates this slightly, saying that the Fed has worsened the cycle's negative effects: "Instead of smoothing out that cycle, [the Fed has] tended to exacerbate it," generally providing too much credit. Ultimately, she says, this can lead to irrational exuberance. Whether or not this would be universally true, many economists do blame former Federal Reserve Chairman Alan Greenspan's policies for encouraging the housing bubble that sparked the economic crisis.

[See why there may be reason to be optimistic about jobs.]

A New Regulatory System

The Fed does much more than determine the monetary base; its chief functions also include supervising and regulating banks--arguably very important functions, especially post-financial-crisis. Without the Fed in place, a new entity would have to perform these functions. In Shelton's opinion, this could be done either privately or federally.

More Market-Based Interest Rates

The Fed has been around since 1913, so it seems difficult to envision exactly how a Fed-free monetary system would look. According to Kroszner, without a central bank, the U.S. might revert to the system in place before the creation of the Fed: one of private clearinghouses that would determine short-term liquidity, altering short-term interest rates. However, Kroszner points out, longer-term rates are already largely determined by supply and demand.

A Fairer Banking Industry?

"Fairness" is, of course, subjective, but Fed critics argue that two of the Federal Reserve's chief functions--selling bonds and regulating banks--are at cross purposes and make for an unfair market. "If [the Fed] goes into a community bank and says, 'We're very uncomfortable with your loans to entrepreneurs...but we won't penalize you at all if you buy U.S. Treasury bonds,' that's a huge conflict of interest. That makes me uncomfortable, that the Fed has the inside track on the financial resources of the country," says Shelton.

--Read why Cyber Monday can be bad for state budgets.

--See how the payroll tax cut extension could help the U.S. economy.

--See a slideshow of the many faces of Ben Bernanke.



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