– March 7, 2020
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Judy Shelton, President Trump’s nominee to the Federal Reserve board, got little love in her pre–Valentine’s Day confirmation hearing. (Shelton was previously the director of the Sound Money Project, prior to its moving to AIER.) Regardless of what criticisms may be levelled against Shelton, she is absolutely right about one thing: the Fed is operating outside the rule of law and needs to be reined in.

Several years ago, when the financial crisis (and the extraordinary policy responses taken by the Fed to combat it) was still at the forefront of public conversation, Shelton contended that the Fed was “almost a rogue agency.” No doubt many will balk at this view. But it is far from absurd.

Indeed, former Fed Chairman Paul Volcker put forward a similar view in a speech before the Economic Club of New York: 

Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the marketplace. To meet the challenge, the Federal Reserve judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending certain long embedded central banking principles and practices. The extension of lending directly to non-banking financial institutions – while under the authority of nominally “temporary” emergency powers – will surely be interpreted as an implied promise of similar action in times of future turmoil. What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time- honored central bank mantra in time of crisis – “lend freely at high rates against good collateral” – to the point of no return.

And Volcker – like Shelton – was right to castigate the Fed’s policy response to the crisis. The Fed had transcended long-embedded central banking principles and practices. It had become almost a rogue agency.

The Fed today operates outside the rule of law. Its lawlessness stems from its shifting agenda and mandate over the decades. Many of the de facto changes in Fed policy and procedure occurred without any sort of a de jure grant of power.

In a 2011 interview with the Atlas Network, which was recently cited by CNN, Shelton expresses this position clearly:

For an agency that was created in 1913 to play a very passive role of temporarily providing liquidity, basically when farmers seasonally needed more money and the banks would run out of cash, then it was the Fed’s role to make sure that we could provide the cash knowing it was always backed by future productivity. Now the Fed is this, this behemoth. So I appreciate when individuals say, well, what we have to do then is start reining them in. Maybe Congress has given up its own responsibility defined by the Constitution to regulate money. We farm that out to the Fed. The Fed has gotten Potomac fever. So now we’re going to start reining them in.

Is this a widely held view? No. But, in this case, the facts are on Shelton’s side. 

The Fed was originally intended to be a formalization of the interbank clearing system under the old National Banking System. It was not supposed to be a central bank conducting anything like monetary policy. Even the advocates of the Federal Reserve Act at the time disavowed such a role for the Fed, because it was widely perceived to be incompatible with the American spirit of self-governance. But over time – and always with an excuse – the Fed came to experiment with new powers that eventually culminated in today’s unlawful regime. 

We cannot fall into the trap of thinking the answer to a lawless Fed is direct congressional oversight. Perhaps the only thing worse than a central bank run by Ph.D.s with technocratic delusions of grandeur is a central bank that answers to politicians on short-term electoral cycles.  Nevertheless, the Fed is a creation of Congress, and Congress can bring it to heel. This should be done by specifying a monetary policy rule for the Fed, one open to very little interpretation and susceptible to minimal tinkering.

Shelton’s particular views on the gold standard are unorthodox, and her recent calls for easy money – a seeming extension of Trump’s Twitter feed – are deeply troubling. But on this issue, she is undoubtedly correct. Until and unless we force the Fed to adhere to the rule of law, we will continue to have periodic macroeconomic crises caused by irresponsible central bankers.

Alexander W. Salter

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Alexander W. Salter is an Assistant Professor of Economics in the Rawls College of Business and the Comparative Economics Research Fellow with the Free Market Institute at Texas Tech University. His research interests include the political economy of central banking, NGDP targeting, and free (laissez-faire) banking. He has published articles in leading scholarly journals, including the Journal of Money, Credit and Banking, Journal of Economic Dynamics and Control, Journal of Financial Services Research, and Quarterly Review of Economics and Finance. His popular work have appeared in RealClearPolitics and U.S. News and World Report. Salter earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Occidental College. He was an AIER Summer Fellowship Program participant in 2011.

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