The Myth of Fed Independence
Following the June 13, 2018 Fed Funds rate target hike (1.75% – 2.00%) by the Federal Open Market Committee – the fifth since January 2017, and the second this year – President Trump drew widespread opprobrium for his public response: “I don’t necessarily agree with it. I’m not thrilled because we [note: the President was likely referring to equity indices] go up … they want to raise rates again.”
With that came a blizzard of upbraid. The New York Times dubbed Trump’s comment “highly unusual”. USA Today added that by making the comment, Trump “br[oke] a longstanding taboo”, while the Washington Post lamented that the President had “violate[d] another Presidential norm.”
Not long after the comments, the White House issued a statement: “Of course the President respects the independence of the Fed … [H]e considers the Federal Reserve Board Chair Jerome Powell a very good man and … he is not interfering with Fed policy decisions.”
In fact, though, the President’s comment doesn’t qualify as unusual, nor does it breach any longstanding codes of conduct; instead, it exposes one of the most sturdily-held shibboleths of American economic policy: the “independence” of the United States Federal Reserve Bank.
While it ostensibly “make[s] monetary policy independently of short-term political influence”, the Fed is irrevocably thrust into the political sphere, and political actors have long sought to influence its policymaking.
Going back to the 1920s, American Presidents have both explicitly and implicitly requested, cajoled, and even threatened the central bank’s officials. Moreover, there is evidence that Fed officials have periodically acceded to those demands.
The Fed’s Institutional DNA Is Political
Consider first that the Fed’s very structure – initially designed and modified over time to placate various public and private interests – doesn’t so much allow as facilitate political influence.
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Fed officials are appointed by the Executive Branch and confirmed by Congress; many rise to prominence through positions at the U.S. Treasury or on the Council of Economic Advisors.
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Private meetings between the Fed Chairman and Presidents are a long-standing fixture of economic policy coordination and implementation;
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The Fed Chairman and other Fed officials testify publicly before Congress twice every year, which includes a sometimes-contentious question-and-answer session;
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Leadership at the regional twelve Federal Reserve Banks are made up of appointees of the member banks which essentially own them; not by the President or Congress, but by regional bankers and business executives. (Historically, they tend to be more hawkish than the seven governors of the Federal Reserve, who are appointed by the President and confirmed by the Senate);
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In times of war, disaster, or under other unusual circumstances, the Fed is expected to work closely with the U.S. Treasury and other government agencies to coordinate monetary, fiscal, and other policy initiatives.
Even with this mixed private-public structure, the Federal Reserve was partially immune to the full range of political manipulation for its first six decades by virtue of the gold standard: with the gold price pegged amid the international system of fixed exchange rates, Fed control of the growth of the money supply was bound. But with the end of the dollar’s convertibility to gold in 1971, and thus the end of exposure to market discipline, the way was paved for the complete politicization of the Federal Reserve.
Mission Creep and Incentives
Upon its founding in 1913, the Federal Reserve’s exclusive mandate was to prevent financial panics and bank runs. This was the case until 1946 when, inspired by both the Great Depression experience and millions of veterans returning to the workforce from foreign battlefields Congress passed the Employment Act. This added to the Fed’s mandate the requirement that monetary policy be conducted in a way that promotes “conditions under which there will be afforded useful employment opportunities … and to promote maximum employment, production, and purchasing power.” The 1978 Full Employment and Balanced Growth (“Humphrey-Hawkins”) added “reasonable price stability” to the Fed’s mandate, additionally requiring that the Board of Governors conduct monetary policy in a way that “maintains long-run growth”, that they transmit a monetary policy report to Congress twice a year, and conduct monetary policy in conjunction with, and in support of, the economic policy and goals of the Executive Branch. (It has been suggested that the addition of financial stability to the Fed’s duties in the wake of the 2008 financial crisis effectively constitutes a third mandate.) As the Fed’s mandate has expanded into the macroeconomic realm, it has necessarily been tied increasingly to elected officials. Add in the unique characteristics of monetary policy – that unlike fiscal policy, it can be implemented effectively immediately, affects the economy generally, and requires neither deal making within or the approval of the Legislative Branch – and the litany of incentives for exerting political influence upon Fed officials is clear. Presidents attempting to influence the Fed did not start with, and will not end with, the current Chief Executive. But with specific reference to direct, public jawboning of the type which the media have taken the current President to task for, a partial list of previous examples bear listing. Lyndon Johnson, in his 1967 State of the Union address, made the following statement: “Monetary conditions are also easing. Most interest rates have retreated from their earlier peaks. More money now seems to be available. Given the cooperation of the Federal Reserve System, which I so earnestly seek, I am confident that this movement can continue. I pledge the American people that I will do everything in a President’s power to lower interest rates and to ease money in this country … toward easier credit and toward lower interest rates.” The Nixon tapes hold copious evidence of direct and indirect attempts to influence the Fed. Publicly, Nixon had this to say upon appointing Arthur Burns to the Fed Chairman position in 1970: “Ladies and gentlemen, as all of you know, the Federal Reserve is independent, certainly independent of the President, although the Congress would suggest that it is not independent of the Congress. I respect that independence. On the other hand, I do have the opportunity as President to convey my views to the Chairman of the Federal Reserve in meetings with … the Secretary of the Treasury and the Chairman of the Council of Economic Advisers … I have some very strong views on some of these economic matters and I can assure you that I will convey them … I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed.” And in a later phone call between Nixon and Burns (via transcript): Nixon: “Arthur, [garbled]. You’re independent! [Burns laughs]. Independent! You get it up. I don’t want any more nasty letters from people about it. OK?” Burns: “That [no more nasty letters], I can’t guarantee.” Later, Nixon: “The whole point is, get it [the money supply] up. You know, fair enough? Kick it!” With skyrocketing inflation in the late 70s, the Fed under Chairman Volcker began a grueling interest rate hiking campaign. Knowing that the continuation of continually higher rates would be politically damaging with an election a few months away – and under pressure from both certain sectors of Congress and organized labor – Carter announced the following alternative, a restraint on the growth of credit, during a televised broadcast in 1980, despite the Fed’s opposition: “The traditional tools used by the Federal Reserve to control money and credit expansion are a basic part of the fight against inflation. But in present circumstances, these tools need to be reinforced so that effective constraint can be achieved in ways that spread the burden reasonably and fairly. I’m therefore using my power under the Credit Control Act of 1969 to authorize the Federal Reserve to impose new restraints on the growth of credit on a limited and on a carefully targeted basis. Under this authority the Federal Reserve will first establish controls for credit cards and other unsecured loans but not for secured loans on homes, automobiles, and other durable goods, and second, to restrain credit extensions by commercial banks that are not members of the Federal Reserve System and also by certain other money market lenders.” Reagan’s first State of the Union address in 1981: “The final aspect of our plan requires a national monetary policy which does not allow money growth to increase consistently faster than the growth of goods and services. In order to curb inflation, we need to slow the growth in our money supply. Now, we fully recognize the independence of the Federal Reserve System and will do nothing to interfere with or undermine that independence. We will consult regularly with the Federal Reserve Board on all aspects of our economic program and will vigorously pursue budget policies that’ll make their job easier in reducing monetary growth.” George H. W. Bush speaking to the New York Times in 1992: “I’d like to see another lowering of interest rates. I think there’s room to do that. I can understand people worrying about inflation. But I don’t think that’s the big problem now … I think inflation appears to be pretty well under control. I don’t think the argument that lowering the rates will stimulate the long-term — shoot the long-term rates up — is valid anymore. And so, yes, I’d like to see it come down.” Clinton strongly signaled that his relationship with the Fed would be prominent going forward by his placement of Fed Chairman Alan Greenspan at his first State of the Union address in January 1993: “Tongues began to wag when Federal Reserve Chairman Alan Greenspan appeared at President Clinton’s State of the Union address sitting between Hillary Rodham Clinton and Tipper Gore. What on earth was the conservative, Republican, inflation-fighting chairman of the nation’s central bank doing sitting next to the wife of the liberal, Democratic, growth-boosting president? Startled financial analysts and even some Fed officials wondered why Greenspan would send such a dramatic signal that he was making common cause with Clinton. Simply by sitting there, he appeared to be sacrificing a slice of the Fed’s vaunted independence … In early December, when Clinton invited the Fed chairman to fly to Little Rock, Ark., to discuss economic policy issues, the scheduled hourlong session stretched to 2 1/2 hours and included lunch. They clearly had hit it off.” George W. Bush, arriving in Washington D. C. after his contentious election, similarly signaled the pivotal nature of the Fed in his Administration’s plans by making his first stop a breakfast with then-Chairman Alan Greenspan. “Mr. Greenspan, who was welcoming the fourth president to pass through during his 13-year tenure, briefed Mr. Bush on the state of the economy. He may also have indicated whether, as the stock market expects, he will announce a loosening of the Fed’s monetary policy by reducing interest rates today. Mr. Bush was forthright in his admiration for Mr. Greenspan, who took the key job in 1987. He said, laying his hand on the chairman’s shoulder: “I talked with a good man right here. We had a very strong discussion about my confidence in his abilities … For part of their breakfast the two men were alone together, later being joined by Vice President-elect Dick Cheney and members of the new administration’s prospective economic team.” Unsurprisingly, President Obama’s public record shows little by way of comments directed at Federal Reserve officials or pertaining to Fed policies. With the Fed Funds rate target set below 0.5% for the duration of his Presidency, the effective zero boundary precluded action other than a return to higher rates. The entire exercise of introducing evidence that the Fed that isn’t politically independent is moot from the start, though; for despite what numerous media outlets have taken the President to task for, the Q&A section of the Richmond Fed asserts that in fact, “the Federal Reserve can be more accurately described as ‘independent within the government’ rather than ‘independent of government.’ ” The difference between the two is an exercise left for the reader to decipher. In the spirit of a gedanken experiment, though, consider what true, complete political independence, ‘within’ or ‘of’ the government, would require: at the very least, every one of the Fed’s political ties – appointments, testimony, the ability to expand or reduce their mandate, and so on – would have to be severed. Additionally, to inoculate them from indirect political pressure, the identity of Fed officials would have to be essentially secret. As currently structured and with the raft of directives that it labors under, it is cogent to expect elected officials to attempt to forcibly maneuver Fed actions; it has been going on for decades before the current President took office and, barring changes, will continue to. That any major institution exercising as tremendous a mandate as managing the money supply of the world’s largest economy (and the world’s reserve currency, to boot) would be able to maintain independence with this structure – let alone the semblance of it – is a testament to some combination of delusion and wishful thinking. Factor in steadily increasing mandates and the flexibility of monetary policy implementation, and the feasibility of an apolitical central bank becomes an embodiment of the Hayekian adage that economics is a constant lesson in letting men know what they cannot design. Peter C. Earle, Ph.D, is a Senior Research Fellow who joined AIER in 2018. He holds a Ph.D in Economics from l’Universite d’Angers, an MA in Applied Economics from American University, an MBA (Finance), and a BS in Engineering from the United States Military Academy at West Point. Prior to joining AIER, Dr. Earle spent over 20 years as a trader and analyst at a number of securities firms and hedge funds in the New York metropolitan area as well as engaging in extensive consulting within the cryptocurrency and gaming sectors. His research focuses on financial markets, monetary policy, macroeconomic forecasting, and problems in economic measurement. He has been quoted by the Wall Street Journal, the Financial Times, Barron’s, Bloomberg, Reuters, CNBC, Grant’s Interest Rate Observer, NPR, and in numerous other media outlets and publications.A Brief History of Jawboning
Expect More of the Same
Peter C. Earle
