In the middle of July 2018, President Donald Trump said in an interview that he was “not happy” with the Federal Reserve nudging up interest rates and threatening economic growth in the United States. At the recent Jackson Hole, Wyoming, meeting of global central bank leaders, the Federal Reserve chair, Jerome (“Jay”) Powell, said the Fed board would continue to act independently of politics and move interest rates up to ensure a stable economy with limited price inflation.
Lost in the exchange was one simple question: should it be the business of any central bank to be targeting or setting interest rates, or should this be the business of the market forces of supply and demand, as with any other price in the economy?
Market Prices Coordinate Supply and Demand
Let’s recall what it is that market-based prices are supposed to do. First, they are meant to bring the two sides of any market into coordinated balance — that is, to bring the buying plans and desires of willing demanders into balance with the producing and selling plans and desires of willing suppliers.
When a price is too high, it means that the amounts of a good that producers are offering on the market are too high for the buyers to be willing and able to purchase all that is being supplied. Facing a surplus of unsold inventories in excess of any planned levels, sellers competitively reduce the price of the good to entice demanders to purchase more.
If the price is too low, it means that the amounts of any good that producers find profitable to offer on the market are less than the quantities that interested and willing buyers would like to purchase. This shortage of a good tends to bring about a competitive bidding up of the price to induce sellers to produce and market more of it.
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