F is for “Fractional Reserve Banking”. Download the whole ABCs for free here, and the whole book for just $2.

Does Trump Need a Primer on Monetary Policy?

Janet Yellen says he doesn’t understand what the Fed does.

Earlier this week, former Fed Chairwoman Janet Yellen accused the President of not understanding what the Fed does:

“I doubt that he would even be able to say that the Fed’s goals are maximum employment and price stability.”

My first thought when I read this was that Yellen is not going to persuade anyone with that kind of language. No one likes to be lectured, and it would be hard for Trump not to perceive Yellen’s comments as an attack, to which the most natural response would be retaliation — most likely in the form of a rude nickname like “Yellin’ Yellen.”

My second thought was that the dual mandate of maximum employment and price stability has been an unsuccessful experiment, anyway. The Federal Reserve has presided over more than a century of wild booms and busts, and it can never quite seem to get its messaging straight — largely due to the conflicting nature of these goals.

It would be hard for Trump not to perceive Yellen’s comments as an attack, to which the natural response would be retaliation — most likely in the form of a rude nickname like “Yellin’ Yellen.”

A war of words between the President and either the current or former Fed Chair would be bad for the economy and worse for the country. Even if Yellen is right that Trump doesn’t have a good grasp on the economy, wouldn’t the better approach be to try to explain what the Fed is up to in simpler language that average people can understand?

Monetary policy doesn’t have to be overly complicated. I recently published a primer on the topic that walks the reader through an “A-B-C” glossary of the terms that normally obscure what are actually fairly straightforward ideas.

The Fed primarily exists to restore equilibrium in the unique market for money. A monetary disequilibrium throws all other markets into disarray, since a change in the value of the dollar screws with the relative values of all goods and services priced in dollars. Under a fractional reserve system, an increase in the demand for money can make devastating ripples through the rest of the economy if there’s not an institution to step in supply the difference.

During the Great Depression, people’s incomes fell by 30% because of a downward spiral of the hoarding of gold and money, followed by deflation, followed by a collapse in investment, employment, incomes, spending, and on and on.

My book goes into this in more depth, but at less than 100 pages, it doesn’t go so deep as to put the reader at risk of drowning in jargon. The ABCs of the Austrian Business Cycle features interviews with three economists who are all bloggers and excellent communicators:

Each one explains a part of how monetary policy works, and offers their theory for why the Federal Reserve has been unsuccessful in bringing booms and busts under its control since its founding in 1913.

The final section, featuring Scott Sumner’s interview, makes a strong case for collapsing the Fed’s dual mandate into a single, achievable target of stable nominal incomes (real output + inflation). A nominal GDP target means that inflation can rise during downturns, without ever turning into runaway inflation, and fall when the economy would otherwise be “overheating.” Best of all, it could be almost completely automated, and there would be no confusion over whether or not the Fed was doing its job.

Shifting to nominal GDP targeting has been widely discussed on blogs, and is making its way into the mainstream consciousness, but has probably not yet found an audience in the White House. If the President wants to prevent the Fed from sabotaging the economic recovery — without being accused of bullying or damaging the Fed’s reputation as an independent institution — he might suggest that his appointee do a better job of explaining the Fed’s policy moves to the public.

Toward that end, people should also read my book.

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