The Federal Reserve met last week, upping its target for short term interest rates. That we will return to the range of interest rates that prevailed for decades is about as noteworthy as the sun rising in the east. Yet the media and financial institutions focus enormous attention on the minutia of how and when that plays out.
Unfortunately, nearly everyone has been ignoring more important news about the Fed undergoing a de facto change in its relationship with the executive and legislative branches of our government. This change directly counters the intent of the legislation that set up the modern Fed 80 years ago and the practice followed by congressional leaders of both parties for 60 of those years. The new approach emerging now also directly opposes a broad consensus among economists on the best structure and governance of a central bank.
One element of this stealthy change is an increase in the ability of a president to influence Fed policy by naming members of the Board of Governors. The second is that committees in Congress, particularly in the House of Representatives, are attempting to directly issue orders to the Board of Governors on key issues. Both of these contradict policies set in place in the mid-1930s.
The historical background must be understood to evaluate what is going on now.
In the years following the stock market crash of 1929, it became clear to many that reason the Great Depression was so severe and prolonged was because the Federal Reserve failed in its mission of stabilizing our nation’s economy. This was due to its overly decentralized structure, itself dating back to a historic political compromise between competing populist impulses and the desires of the financial establishment, following the Panic of 1907.
The compromise was the formation of a decentralized central bank consisting of 12 autonomous regional banks and a powerless board in Washington, D.C. This decentralization had contributed to an unsustainable bubble in asset prices in the late 1920s. But more damaging was that the same undue decentralization neutered the Fed’s ability to maintain the money supply and counter the collapse of economic activity that followed the 1929 bust. The economic damage and harm to people was enormous.
The resulting revision of the Federal Reserve Act did not abolish the basic decentralized structure of 12 banks. But it did modernize the Board of Governors to the current one of seven members, appointed by the president and confirmed by the Senate.
There was consensus that this board should be free of political influence. So the governors were given long and staggered terms of 14 years. The terms began in even years so that no single president could appoint a majority-establishing fourth member of the board until in the last year of a two-term presidency. The intent was clear: The Fed was not independent of the executive branch, or of Congress for that matter, but it was given great autonomy and insulation from politics while remaining within government.
In practice, many governors preferred not to stay on for 14 years and there were occasional deaths, so some presidents did name four members ahead of time. But regardless of the party occupying the Oval Office, Board nominees tended to be non-controversial centrists, either bankers or economists. So early appointments had no practical effect on the make-up of the board.
Confirmation hearings gave Fed critics in the Senate a chance to air their views, knowing this street theater would have no impact on the final vote. Of any entity administered by such a presidential-appointment-senatorial-confirmation system, the Fed board was among the least partisan, more like the FDA or FCC than the National Labor Relations Board or Securities and Exchange Commission..
This bipartisan consensus ended in 1997 when Bill Clinton became wounded prey because of the Monica Lewinsky affair. A GOP-majority Senate, operating in the hyper-partisan legislative ambience pioneered by House Speaker Newt Gingrich, decided it would simply ignore Clinton’s appointments to the Board, leaving seats open for his successor in 2001. Clinton made a serious error, in my view at least, by acceding to the threat and not even naming anyone to vacancies.
So there were two open positions for George W. Bush to fill upon taking office and another one on Jan. 20, 2002. By the end of his first term, Bush had appointed a majority of the board.
Democrats, unfortunately, played the same game with their brief control of the Senate at the end of Bush’s second term, putting Barack Obama in an identical position position of having two seats he could immediately fill.
But the GOP upped the ante with Obama, refusing to consider an appointee for one open seat unless his nominee be paired with someone tacitly chosen by Republicans to fill a second open seat. This usurpation of a president’s statutory power of nomination by Congress should have provoked a constitutional crisis, but Obama, following Clinton’s precedent of 1998-2000, did not force a fight.
Later the GOP majority refused to consider Obama appointees to the last vacancies that appeared in the last half of his second term.
Combine that with a recently-announced resignation of Governor Daniel Tarullo and President Donald Trump has three open seats to fill immediately. He will be able to name a fourth less than a year from now. That means he will have named a majority of the board one year into his presidency rather than the seven years envisioned in the law.
What does it matter? As long as presidents name competent, pragmatic moderates no harm is done. But the framers of the current Fed structure thought that ensuring policy continuity and insulation from electoral politics was important enough that an elaborate structure be written into law. That structure now is effectively a dead letter.
That would not matter as much if members of both houses of Congress clearly understood their proper relationship with the central bank of a modern economy such as ours. Some members clearly do not, as evidenced by a couple of what I believe are extremely unwise letters sent by chairs of House committees to current Fed Chair Janet Yellen.
One, from Patrick McHenry of North Carolina, takes the Fed to task for continuing to consult with other central banks on issues of monetary policy and bank regulation, especially common international standards for bank capital. The letter, sent only a few days after Trump’s inauguration, says that the Fed should be getting with the Trump’s program of reduced U.S. participation in multilateral relations with other countries.
A second letter came from Jeb Hensarling of Texas, chair of the House Financial Services Committee. In it, he orders the Fed to stop ongoing rule-making regarding banking supervision until the Trump administration has a chance fill a position. He further threatens that if the Fed does act, Congress will pass legislation overruling whatever it does. To Minnesota’s shame, Rep. Tom Emmer is one of the 33 other signatories.
Wise drafters of the existing Federal Reserve Act structured the Fed to insulate it from political pressure, particularly that which might be brought by a new presidential administration. Now these House members are trying to do exactly what economic research and decades of experience in dozens of countries says not to do. They are trying to make the Fed dance to the tune of politicians.
Why does it matter? The clear answer is that the status of the U.S. dollar as the globe’s primary reserve currency, one sought out by people from all other nation’s as a safe store of value, depends on continued world confidence in the autonomy of the Federal Reserve. There is 80 years of history, admittedly with some blemishes, of the Fed being an institution that takes its responsibilities as the manager of our currency very seriously and very responsibly. Only the German and Swiss central banks have the same level of public respect.
If we move to presidents being able to pack the Board of Governors with sycophants or to House committees dictating monetary policy or the details of financial supervision, confidence in the U.S. dollar will erode rapidly. Having our currency be a medium of exchange and store of value for billions of other people may not be an “exorbitant privilege” as some foreign critics claim, but, on the whole, we are far better off with the dollar as a respected and desired currency that as one viewed askance because we chose to flout wise legislation and sacrifice 80 years of sound precedent.