Who Needs Central Banks? Nobody

Central banks, particularly the Federal Reserve System, have continued to exacerbate inflation and boom-bust cycles in the name of 'stabilizing' the economy.

Murmurs are heard around the world as the Federal Reserve raises its lending rate to a range of 0.25–0.50 percent, with financial commentators forecasting disaster due to increased demands imposed on the cost structures of enterprises recuperating from pandemic lockdowns. The Federal Reserve is the head of a global network of central banks that are purportedly mandated by their respective governments to promote economic stability and smooth functioning.

The supposed legitimacy of central banks is based on three common goals shared by central banks all around the world. The first objective is price stability, which is defined as the view that central banks should adjust the money supply in response to genuine demand and supply pressures in the economy. The second goal is to boost macroeconomic growth prospects by lowering borrowing costs, which is meant to encourage enterprises to expand their investments, resulting in increased output and overall growth.

Finally, taking countercyclical policies, which are activities taken by the central bank to offset high unemployment rates that may arise from decreased output during a business cycle trough, is the final goal.
Stability in Prices

The central bank's job in maintaining price stability essentially consists of managing the value of money, i.e., preventing general inflation or deflation. A basket of goods is weighted in terms of expenditures on them, and their price variations are followed as a proxy for changes in the economy's overall price level.

The index's gain or reduction in value is assessed using a constant percentage growth rule. The central bank intervenes with its monetary policy instruments to impact the value of money in the markets when the index's value rises or falls faster than the predetermined rate of steady growth, which is normally 2%.

While the goal of conserving money's value is admirable, it is flawed by a misunderstanding of the function of increasing and falling prices in the market economy. Prices serve as coordinating signals, disseminating information about critical economic data in a decentralized manner. When an object becomes scarce in the market, rising prices warn consumers to save on it while also pointing out a more profitable use of resources to suppliers, who expand supply of the product until supernormal profits are fully exploited, lowering its price in the process.

As a result, when the prices of products in the basket of goods rise, the value of the index rises, giving the central bank a cause to intervene in the market to counteract the price increases, although doing so interferes with the market process. This inhibits entrepreneurs from profiting from high-profit prospects; if price rises are caused by demand-pull inflation, the intervention also hinders consumers from receiving items that might improve their financial situation.
Countercyclical Goals and Macroeconomic Growth

The variations of the economy's actual growth rate from its long-run trend rate of growth are used by modern central banking to track ups and downs. To put it another way, a growth-cycle upturn (downturn) is characterized by growth that is faster (slower) than the long-run trend rate. The closeness between an economy's present growth rate and its predicted growth rate based on long-term patterns is used to assess its health. Other lagging and leading indicators used by central banks to assess the current state of the economy include consumer confidence surveys, weekly work time surveys, and industrial output indexes.

Various monetary policy instruments are used to impact the demand and supply of money in the economy to achieve the goal of bringing the economy back on track when the present growth level or the value of the indicators show that the economy needs to be encouraged. When central banks aim to cut the cost of borrowing for businesses, they also lower the cost of lending for commercial banks, lowering commercial banks' own interest rates. Reduced interest rates are expected to cut the cost of borrowing for businesses so that the return on an investment is marginally larger than its cost, resulting in a rise in investment and output via the multiplier effect.

While such efforts to combat falling output and spending may appear sound at first glance, they deserve a closer examination because central bankers' actions have a disproportionate impact on the economy. The overall expenditure in the economy is divided into two categories: spending to sustain the production system and spending on final products. Spending on the structure of production includes capital investments to boost company productivity and scale, as well as circulating capital, which is utilized as an input to produce outputs, whereas consumer spending on finished goods and services is referred to as spending on final products.

Firms frequently set aside a portion of their income to utilize as a fund for future capital projects. When corporations save instead of spending, output may fall; however, this is not an indication of poor economic health; rather, it is a process that the economy must go through in order to achieve improved productivity, innovation, and efficiency in production as a result of lower costs.

Firms' capital structures alter as they upgrade their machines or expand their scale, resulting in increased efficiency. As the number of things produced per unit of money spent rises, the value of money rises as well.

A drop in output would quickly taper off to a higher level of productivity and prosperity for the economy, but Cantillon effects occur if the central bank intervenes with an easy money policy to lower the cost of borrowing. Savers lose because more fictitious money is created, lowering the value of their money and causing inflation.

Easy money policies encourage unsustainable booms, which eventually lead to capital misallocation when capital is channeled in unsustainable directions. Each business decides what to invest in based on a cost-benefit analysis. When costs are artificially cut by lower interest rates, previously unprofitable investments appear profitable. However, because such profitability is not based on genuine underlying consumer demand, inflation quickly rises as manufacturers fight for scarce resources.

Increased inflation reduces profit margins that were previously fueled by artificially low interest rates, necessitating new monetary stimulus to maintain present investments from becoming unsustainable. As a result, we argue that central banks cause business cycles and market distortions. As a result, we should reconsider the need for central banks, as they are at the root of many economic problems.


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