reforming the Fed

You hear a lot of griping regarding Ron Paul's stand on getting rid of the Federal Reserve bank, calling him an out & out loonie for wanting to go back to the gold standard and the stringency of 100-percent-reserve banking. I don't know, honestly, what's best. In a world where central bankers are doing their damnedest to weaken their currencies, simply keeping one's true money-supply constant would send the value of one's currency through the roof. Good thing? Bad thing? I dunno.

But I do know one thing: there are actually several different Fed rates out there, and no-one talks about the important one -- the discount rate. The DR is what's used to reflect the true, instant cost of money. When you make a net-present-value calculation using anything other than the discount rate, you're including some sort of premium (usually a risk or duration adjustment). The Funds rate is a different matter: what rate banks are allowed to lend to each other at. I propose keeping the Fed -- we've already got it, and quarter-annually pandering to the credit markets is certainly better than the banana republic we'd inhabit if we trusted Congress to manage our money supply.

But why should the Fed regulate the inter-bank rate? Why not let our banks decide among themselves at what rate they are willing to loan money? By letting the rate float, then banks can increase or decrease the their rates in real-time according to market pressures, instead of having to wait for the Fed to make its pronouncements. If you want guaranteed borrowing, use the discount window or repos. If you want market-adjusted funding with varying risk spectra, then talk to the other banks. This still ensures that banks aren't destroyed during market panics, but takes "policy" out of an equation that by definition must constantly change.

A credit crisis is a shortfall in the supply of credit, no different than a gasoline crisis or a doughnut crisis, and is almost always the result of price controls. President Carter did untold damage to our economy fixing our gas prices, and Mugabe's nearly destroyed Zimbabwe with his own price controls. We don't want to find ourselves in the same boat with money. If we want to avoid long-term disaster in the credit markets, we need to get out of the price-fixing business and let the day-in/day-out players make their moves according to the daily realities they face.