Regular breakfast between the Fed chair and the Treasury Secretary was a long-held tradition. Janet Yellen recently described her tenure as being peppered with chats with President Obama, as he “expressed interest in understanding the economy and the economic outlook”. That’s to say, interactions between the US administration and the central bank are common enough. But what happened last Thursday was different.
Trump’s visit to the Federal Reserve was explicitly antagonistic, meant to exert pressure and influence over the central bank. This was perhaps made most vividly and uncomfortably clear when Trump accused the Fed of going well over its renovation budget and Powell directly contradicted the President. But this is only the latest escalation in a long series of public clashes between Fed Chair, Jerome Powell, and the Trump administration — exactly the sort of thing central bankers want to avoid because it constitutes a threat to the holy grail of macroeconomic policymaking: central bank independence (CBI).
Today such independence is considered sacrosanct: the height of technocratic, expert governance. And any Fed (or IMF) official would tell you today, just as they would have in the Nineties, that it is essential to a healthy and successful economy.
No surprise, then, that the surge in antagonisms between Trump and the Fed has produced a vocal, international response from people directly in support of Powell. They extol his courage and admire his insistence not to bow to the pressure from the administration. For them, Powell is the consummate independent central banker — standing up for the conventional wisdom against a political maelstrom calling for change. But others have taken a slightly different tack, offering a theoretical defence of the independence of central banks in general.
“Such a defence of central bank independence simply isn’t compelling.’
A recent essay in The New York Times trots out most of the widely accepted defences of CBI. The authors, Janet Yellen and Ben Bernanke, who are former central bankers, predictably assert that “the ability of the central bank to act independently is essential for its effective stewardship of the economy”. They go on to assure readers that an independent central bank is not an unaccountable central bank. This is true, to an extent. Congress sets the Fed’s mandate and holds the central bank accountable to it. It is also true that the Fed’s mandate is to secure credit aggregates in line with price stability, maximum employment, and moderate long-term interest rates. In reality the Fed seeks price stability defined as 2% inflation. As Yellen and Bernanke themselves write later in the op-ed, “if inflation is firmly under control, the Fed has more flexibility to respond to any weaknesses in the job market” — suggesting the price stability aim has primacy. Furthermore, while the Fed does have an inspector general tasked with overseeing its decisions, the inspector general at the Fed, unlike any other in the US government, reports to the Chair of the Federal Reserve, not directly to Congress.
But if it’s not a lack of accountability that makes the Fed independent, then what is it? The former central bankers state that “independence means that monetary policymakers are permitted to use fact-based analysis and their best professional judgement in determining how best to reach their mandated goals, without regard to short-term political pressures”. But surely that can’t be right. Don’t we expect policymakers who are not as independent as those as the Fed — education policymakers, environmental policymakers, fiscal policymakers — to use “fact-based analysis and their best professional judgment” when they make policy? Perhaps the key is in the final phrase, “without regard to short-term political pressure”. In which case, independence is not about a lack of democratic accountability, but it is about building in a lack of democratic control over policy. Independence means legislators cannot actively steer policy going forward.
Why would we want this? The common suggestion is that we should insulate Fed policymakers from political influence because monetary policy is simply too complicated and/or too important to be left to politicians. But again, this seems crazy. If congresspeople are too dumb or too frivolous to control monetary policy, why are we happy, nay insistent, that those same dimwits hold the power to declare war, to tax, to spend, and to put people in jail and throw away the key?
Too often, defenders of CBI claim that history supports their view that independence is necessary to secure a stable and growing economy. That’s not my reading of history. First, independence in its current form is rather new. For most of the history of central banks, they were independent not by virtue of their expert status, but because they were privately owned and run — an arrangement most of us have no interest in resurrecting. Second, the evidence in favour of independence since the Fifties is mixed at best. More compelling, in my view, are arguments that suggest independence arrives right when countries need it least. Or in other words, that independence is the product of economic stability, not its cause.
Yellen and Bernanke mention two particular periods of history to defend their claims. First the years immediately following the Second World War when the Treasury pressured the Fed to cap interest rates to help finance war debt. According to the authors, this led to soaring rates of inflation by the late Forties. They go on to suggest that this inflationary period spurred the Fed-Treasury Accord of 1951 which is widely accepted as the birth of modern CBI in the US. But this is somewhat odd from a historical perspective, as the period following the Second World War is generally considered an economic golden age — a fact which suggests that CBI is best understood as a product, not a cause, of economic stability.
Perhaps the most infamous interaction between a Fed chair and a President in economic circles occurred in 1972 when Richard Nixon pressured Arthur Burns to keep interest rates low in the lead up to the election. Yellen and Bernanke suggest that this single instance should be blamed for the Stagflation of the early Eighties — an assertion that seems out of proportion, not least because the stagflation occurred almost 10 years later. They further suggest that stagflation was later brought under control when Paul Volcker “refocused the bank on reducing inflation in the early 1980s”. But this is an odd suggestion to make given the prior historical reference. They claimed that CBI emerged in 1951, in which case, we might ask, why didn’t it prevent the Nixon issue of 1972? Or put differently, if the Fed was independent from 1951, why did Volcker have to “refocus” the central bank on inflation in the Eighties? Far from clearly endorsing independence as essential to effective economic stewardship, history suggests, at best, that CBI is useful for those Fed chairs who want to act against the interests of elected politicians, but by no means acts as a guarantee of low, stable inflation or a healthy economy.
But while there are some parts of the NYT essay that are clearly on point, for example central bank independence does act to undergird foreign investor confidence in the economy, the most important aspect is what is not there: Congress. The power to create money and “regulate the value thereof” is assigned to the legislature in Section 8(5) of the US Constitution. This is still the case, even if Congress has largely failed to use these powers for the past 100 years. The legislature could (in theory) change, guide, or even eliminate the Fed tomorrow with a simple majority vote. Consequently, it’s striking that in discussing theories of central bank independence, Yellen and Bernanke don’t consider the only existing political institution that does in fact hold formal powers over the central bank — the same institution that was intended to control monetary policy.
In short, such a defence of central bank independence simply isn’t compelling. But maybe that’s because that’s not really what it’s about. Maybe the authors are less concerned with defending central bank independence than with defending Powell from Trump. Fine. But if that’s the case, let them say so. At the moment, Trump’s bullying of Powell has caused a mixed and confused reaction amongst the economic commentariat — with some extolling Powell’s spine of steel, others paradoxically calling for him to step down to preserve the Fed’s independence, and still others making stale theoretical defences of CBI more generally. Instead of engaging in these confused and usually rather tepid arguments about theory, if Yellen and Bernanke and others think Trump should back off and let Powell conduct monetary policy, they should say so and stop hiding behind poor theoretical arguments for insulating the Fed from political influence more generally.
There are good reasons for the Fed to be independent of the private sector: the most obvious are the classic arguments against state capture. There are good reasons for the Fed to be independent of the President: a constitutional aversion to the creation of a King, for one. There are good reasons for the Fed to be independent of Donald Trump: most specifically, he’s unpredictable. What is important to recognise, however, is that while important and compelling, all these reasons do not add up to good reasons for the Fed to be independent of the democratic legislature.
