Is the Fed at risk for real this time?
Throughout
American history, few institutions have inspired such persistent
mistrust among voters and their elected officials as the mysterious
authority that determines the value of their money.
The
Federal Reserve wasn’t even around yet when the fiery Nebraska populist
William Jennings Bryan rose to the Democratic presidential nomination
in 1896 by charging that the gold standard that ruled monetary policy at
the time was crucifying the workingman “upon a cross of gold” to serve bankers’ interests — depressing farm prices and crushing indebted farmers by limiting money in circulation.
Since
its inception in 1913, the Federal Reserve has been alternately accused
of either making money too scarce and expensive or making it too
plentiful and cheap.
In 1981, a Democratic congressman, Henry B. Gonzalez of Texas, threatened to introduce a bill to impeach the Fed chairman, Paul A. Volcker, and most of its other governors, accusing them of squelching the economy with tight monetary policy.
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Thirty years later, on the Republican presidential campaign trail, another Texan, Gov. Rick Perry, famously suggested
roughing up the Fed chairman, Ben S. Bernanke, for “printing money” to
stimulate growth: “I don’t know what y’all would do to him in Iowa, but
we would treat him pretty ugly down in Texas.”
On
Wednesday, a Federal Reserve led by Janet L. Yellen — confirmed three
years ago in the Senate by the tightest margin in at least 35 years — is
likely to get a taste of this vitriol.
As my colleague Binyamin Appelbaum noted on Monday,
the Fed is all but certain to raise its benchmark interest rate,
setting itself on a path to prevent an acceleration of the economy and
ward off an uptick in inflation — a course that is in clear tension with
President Trump’s stated goal to stoke growth at all cost.
The
pressing question for this era of populist policy making and popular
anger is whether the Federal Reserve as we know it — arcane and
academic, with the autonomy to set monetary policy as it sees fit — will
survive the tension this time.
Given
the ferocious discontent with the “establishment” stoked by Mr. Trump
among his angry electoral base, the threat against the Fed this time
seems of a higher order. As Adam S. Posen, an American economist who has
served on the Bank of England’s rate-setting Monetary Policy Committee,
told me, “The sense that the Fed’s independence could be taken away by a
simple act of Congress is very real.”
The
pressure is already on. Mr. Posen, who now heads the Peterson Institute
for International Economics, points out that the Fed already lost
powers it deployed to counter the recession spawned by the financial
crisis a decade ago: The Dodd-Frank financial reform legislation
stripped it of its authority to lend freely to nonbanks, which it used
to keep money market funds, insurance companies and others that had bet
on the wrong side of the housing bubble from imploding and taking the
economy with them.
Efforts
that stalled in the last Congress — to subject the Fed’s funding to
congressional approval, to reduce its discretion in setting monetary
policy and to subject it to the oversight of Congress’s Government
Accountability Office — have acquired a new lease on life, cheered from the right and the left.
Disgruntlement in Congress will only grow worse as the Fed gradually winds down the enormous stash of bonds
it built over the last eight years to support the mortgage market and
encourage lending. This will inevitably push up long-term interest rates
and produce paper losses for the Fed as it marks the price of
securities to market.
As Donald L. Kohn, former vice chairman of the Fed, noted in an analysis of the Fed’s independence
three years ago, “it will be a complex exit involving many steps — with
lots of opportunity for kibitzing and objecting over a long period.”
Congressional
action might not be the Fed’s biggest problem. Mr. Trump’s appointments
to the Federal Reserve Board could prove as destabilizing: Two of the
seven positions are vacant, and a third will come open
with the retirement of Daniel K. Tarullo in April. By the middle of
next year, Mr. Trump will also have the opportunity to replace Ms.
Yellen as Fed chief and Stanley Fischer as her deputy.
Alan
S. Blinder, a vice chairman of the Fed during the Clinton
administration, recalls the damage caused in the 1970s by Arthur F.
Burns, who Mr. Blinder said juiced up the economy as Fed chairman to
help President Richard M. Nixon’s re-election bid and cracked down hard
afterward.
“I’m
worried about the people Donald Trump will send over there,” he told
me. “If he sends over toadies beholden to Donald Trump, it would be a
very serious threat to the Fed’s independence.”
So what is Ms. Yellen’s Fed to do?
To a point, this is not just about the Federal Reserve. The European Central Bank, too, is navigating political waters charged with populist mistrust. In Britain, the Labour Party’s shadow chancellor of the Exchequer has called for “democratic control” over interest rates.
The argument for central bank independence
is as powerful as ever. Political influence over monetary policy would
produce more destabilizing booms — as politicians pumped up growth to
serve their electoral purposes — and inevitable busts. Expecting
consistency of elected officials is decidedly risky: The Republican accusation
that the Fed was putting the economy at risk by keeping interest rates
at rock bottom to help the Obama administration will inevitably spin 180
degrees now that Republicans control the White House.
Still,
not all the criticism is mendacious. The popular mistrust of central
bankers should not be ignored. After all, central bankers failed to
prevent the most devastating financial crisis in generations — looking
on idly, at best, while financial institutions peddled shady bonds to
fuel a housing bubble of gargantuan proportions.
And
central banks have emerged, at least implicitly, with a bigger job than
before, adding the preservation of financial stability to their duty to
ensure low inflation and, in the Fed’s case, full employment. Some
central banks — though not the Fed — have been given new tools for this
new job.
Given
this power, it is inevitable that the enormous discretion central
bankers have in executing their mandate will inspire popular mistrust.
“The
financial crisis was very difficult to digest, costly, and had
redistributional consequences,” said Lucrezia Reichlin, former head of
research at the European Central Bank and now a professor at the London
Business School. “Central banks were at the center of the response, so
the demand to open up this discussion is natural. We should not be
afraid of talking about accountability.”
Perhaps.
Perhaps there is a discussion to be had over whether the Fed should
keep its role as supervisor of financial institutions, or whether the
job should be placed with another agency. Maybe financial supervision
should be made more rule-based, less subject to regulators’ discretion.
Maybe
there is a better way for Fed officials to communicate with Congress
and explain the thinking behind their decisions. Maybe the Fed needs
extra tools — to impose limits on indebtedness, for instance, or to
adjust monetary policy to serve measures of financial stability. Maybe
it could benefit from a tweak in its mandate, to ensure a better balance
between its goals of fostering employment and curbing inflation.
And
yet the populist streak driving through American politics seems
unlikely to yield such measured outcomes. The Federal Reserve was
designed to be insulated from the full force of democracy in order to
protect its mandate from political opportunism, to ensure that policy
hewed to technical expertise. It was designed — precisely — to protect
it from a moment like this. One can only hope that the protections hold.
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