The trouble with central banks


The way Dr Yaron Brook (pictured, left) – the president and executive director of the Ayn Rand Institute – explained the problem with central banks in his speech at the ASI this week was a marvellously clear, so it's worth repeating now.

Put simply, interest rates are a price that tells you how expensive credit is.  You base your financial decisions on them accordingly. If the price (interest rate) is low you borrow more, and if it is high you borrow less.

In a monetary system without a central bank, market rates would develop which balanced demand for credit with supply. The money supply would be as stable and dependable as the food supply.

But once the government tries to set this price, they cause distortions. Let's use the food example again: when government attempts to fix food prices, they almost always get it wrong. They either set prices too high, and you get oversupply. Or they set prices too low, and you get shortages.

Food, of course, is a fairly straightforward commodity – and yet government still does not, and cannot, have the capacity to set prices accurately. But despite this fundamental economic truth, we expect a committee of central bankers to put a price on money – something altogether more complex and opaque than food.

So when you think about it, it's really no wonder that they got it so horribly wrong, with the financial consequences we are currently witnessing.