The club of U.S. central bankers appears jittery, but it’s not because of interest rates, unemployment, or mortgage-backed securities. It’s because of Congress.
The Fed appears particularly nervous that Congress will pass Rand Paul’s audit bill and some version of the Federal Reserve Accountability and Transparency Act (the FRAT Act).
Alan Blinder, a former vice chair at the Fed, recently took to the pages of the Wall Street Journal to blast the idea of restricting the Fed with, among other things, the FRAT Act.
Richard Fisher and Charles Plosser, presidents of Federal Reserve District Banks in Dallas and Philadelphia, respectively, criticized the audit idea in an interview with The Hill last week.
Plosser noted that the Fed is already subject to limited audits. He also warned that Paul’s audit bill “runs the risk of monetary policy decisions being based on short-term political considerations instead of the longer-term health of the economy.”
Fisher, a bit more animated, queried: “Who in their right mind would ask the Congress of the United States — who can’t cobble together a fiscal policy — to assume control of monetary policy?”
Excellent question. I could provide a fairly long list, but I’ll stick to one name: Milton Friedman.
Friedman is on record arguing for the Fed to be put under direct control of Treasury or Congress. In a 1984 interview he reiterated his position:
I said before that either bringing it under the Treasury or putting it under Congress would give you more small mistakes. It would worsen monetary policy from month to month, or even year to year, but it would prevent major disasters. You would not have had the Great Depression; you would not have had the inflationary rollercoaster of the last 20 years.
Just to be clear, he also said:
So I’m not overly optimistic about what congressional control can do. However, it would be better than what we have now. As you can see, I am not in favor of the independence of the Federal Reserve. This is a democracy. And I believe that money is too important to leave to [a] central bank, that it is intolerable that a group of nonelected people should have the power to create a major inflation or a major recession. Entirely aside from the economic effects I believe it is not an acceptable political system. To repeat, as a minor change I’d have the Fed made part of the Treasury. As an alternative, it would be better to have the Fed more directly under congressional control.
I think it’s pretty safe to say Friedman was in his right mind.
Regardless of what Fisher thinks, it’s just as valid to ask who in their right mind would not want Congress in charge of monetary policy. By all means, let’s have this debate.
It’s far from insane to argue that Congress – the political body the U.S. Constitution charges with the power to “coin Money” and to “regulate the Value thereof” – should be held directly accountable for monetary policy.
Besides, the notion of Federal Reserve “independence” borders on pure fiction.
It is true that nobody from Congress or the Executive branch calls Janet Yellen every day to tell her exactly where to set the fed funds target. But that’s pretty much the extent of the Fed’s independence.
There are so many pieces of evidence which prove – and that’s a word I rarely use – the Fed is not really immune to even short-term political pressure that it’s hard know where to start.
First, the Fed is nothing but a creature of Congress – it was created via the Federal Reserve Act in 1913. Originally, the Treasury Secretary served on the Federal Reserve Board. It’s pretty hard to argue the Fed was politically independent under that arrangement, which lasted until the 1930s.
And the Fed is the fiscal agent of the U.S. government. The more U.S. debt the Fed holds, the more it enables deficit spending.
Congress also gave the Fed its (inappropriately named) dual mandate, the directive which requires the Fed to focus on full employment.
In what universe are federal debt, deficit spending, and unemployment non-political issues?
Aside from these minor quibbles, it’s not as if Congress – or the Chief Executive – has a history of leaving the Fed alone. They actually have a history of threatening the Fed and, sometimes even following through.
So many scholars have done such an incredible volume of work in this area that I can’t possibly give everyone the tribute they deserve. So I’ll simply link to two papers which, between them, point to most of the original sources. (I apologize to anyone I’ve left out).
One paper is authored by Thomas Cargill and Gerry O’Driscoll, the other is by Daniel Smith and Peter Boettke. (As an aside, the O’Driscoll paper is also a good source for empirical papers that counter statistical evidence of the supposed benefits of Federal Reserve independence).
The Smith-Boettke paper is one of the most comprehensive looks at this issue I’ve seen. It runs through examples of every Fed Chair since 1951, the supposed start of Fed independence.
Here are just a few examples (with Fed Chair dates provided):
- William Martin (1951 – 1970). President Eisenhower directed his Treasury Secretary to put the “utmost pressure” on Chairman Martin to “get a greater money supply throughout the country.” When Martin refused, Eisenhower pressured him to resign or reconsider. Martin reconsidered.
- Arthur Burns (1970 – 1978). President Nixon repeatedly worked with Burns to secure easy monetary policy with the view that it would help win elections. On one of Nixon’s famous tapes, Nixon and Burns openly mocked the idea of Federal Reserve independence.
- G. William Miller (1978 – 1979). President Carter found Miller uncooperative, so he replaced him as Fed Chair (he made Miller his Treasury Secretary).
- Paul Volcker (1979 – 1984). Ronald Reagan openly cultivated a working relationship with Volcker and repeatedly asked him for tighter monetary policy. Alan Greenspan reports that, in one meeting, Reagan reminded Volcker that the Federal Reserve Act was subject to change.
- Alan Greenspan (1987 – 2006). Alan Blinder, appointed to the Fed Board by President Clinton, publicly suggested Greenspan was catering to Clinton.
- Ben Bernanke (2006 – 2014). A 2012 New York Fed publication notes: “The U.S. Treasury and the Federal Reserve System have long enjoyed a close relationship…. This relationship proved beneficial during the 2008-09 financial crisis, when the Treasury altered its cash management practices to facilitate the Fed’s dramatic expansion of credit to banks, primary dealers, and foreign central banks.”
Perhaps the Fed’s defenders have some other definition of independence in mind?
It’s sort of paradoxical, but one good way for the Fed to resist political pressure would be to follow a monetary policy rule. This idea, of course, is also being pilloried.
Alan Blinder is a well-versed critic of rules-based policy. He recently suggested that, while a policy rule – such as the Taylor rule – would be a “useful benchmark” in “normal” times, we wouldn’t want the Fed tied to a rule in bad times “out of fear of congressional browbeating.”
But if Congress does tie the Fed to a rule, who would they browbeat?
Incidentally, two economists actually won a Nobel-prize for showing that rules-based monetary policy would produce better economic outcomes than a pure discretionary framework. So maybe the idea has some merit.
Blinder also warns against curtailing the Fed’s emergency lending powers, an action he sees as “the biggest threat to the Fed and the economy.” But the Fed has a long and miserable record of lending to insolvent/failing banks and nonbanks.
That kind of lending has always been – and always will be – a political issue.
The Fed could easily avoid such conflict because there is no clear economic rationale for the Fed to provide direct loans to private firms. The truth is the Fed can implement monetary policy and provide liquidity to the banking system without emergency lending powers.
And if nonbanks have trouble getting credit in a crisis, well, maybe there’s a good reason.
Voters recently rejected the big-government, big-business cronyism they got in the wake of the 2008 crisis. Over these next few months, Congress’ actions will reveal whether they got the message.
If Congress engages in real Federal Reserve reform, we’ll know the answer.
Originally appeared on Forbes.com.
Source material can be found at this site.
