Banks have $1.5 trillion in cash on their balance sheet in excess of their legally required reserves...

What's Wrong With the Federal Reserve?

by Allan H. Meltzer 

By allowing its monetary policy to be influenced by elected politicians and market speculators, the Federal Reserve is putting its independence at risk. It is also neglecting basic economics, which was a great strength of its current chairman, Ben Bernanke.Consider the response to last week's employment report for June—a meager 80,000 net new jobs created, and an unemployment rate stuck at 8.2%. Day traders and speculators immediately clamored for additional monetary easing. Even the president of the Federal Reserve Bank of Chicago joined in.To his credit, Mr. Bernanke did not immediately agree. But he failed utterly to state the obvious: The country's sluggish growth and stubbornly high unemployment rate was not caused by, nor could it be cured by, monetary policy. Market interest rates on all maturities of government bonds are the lowest since the founding of the republic. Banks have $1.5 trillion in cash on their balance sheet in excess of their legally required reserves—far more than enough to meet any unsatisfied demand for loans that bankers regard as prudent.

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One of the many costs of the Fed's excessive attention to the near-term is that it will wait until after the inflation is upon us before it does anything to stop it. The Fed's view is that by raising interest rates enough, it can stop any inflation. True, but not entirely relevant. Will the politicians, the public, business and labor accept the necessary level of interest rates? Much history says: "Don't count on it." Better to adopt something like the Taylor Rule and begin gradually reducing the banking system's excess reserves now.

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