Malignant Monetary Monocentricity.

• Author: Salter, Alexander William
• Position: Federal Reserve - Report

Monetary Institutions: Monocentric versus Polycentric

The monetary authority of the United States, the Federal Reserve, is widely perceived to be independent of politics. Founded with the relatively limited intention of formalizing the interbank clearing system, it would soon morph into a true central bank, acquiring additional protections from political interference over time (Hetzel and Leech 2001; Bernanke 2010; Bordo and Prescott 2019). Perhaps the most noteworthy event is the Fed-Treasury Accord of 1951, inaugurating a formal separation of the monetary authority from the fiscal authority. Today, the Fed is regarded as an apolitical and prudent steward of the macroeconomy with a wide range of duties, from maintaining macroeconomic stability during ordinary times (e.g., standard open-market operations) to combating financial panic during extraordinary times (e.g., its response to the 2007-8 crisis). The combination of institutionalized apoliticism and expert governance--monetary policy makers are typically drawn from elite circles in law, finance, and academic macroeconomics--is important for the Fed's prestige.

Undoubtedly those at the helm of the Fed are impeccably trained. But the popular view of the Fed as insulated from politics is simply mistaken. The Fed always has been and always will be a creature of politics (Boettke and Smith 2013, 2015). President Lyndon Johnson famously called his Fed chairman, William McChesney Martin, down to his ranch to browbeat him. The pressure President Richard Nixon placed on Arthur Burns for accommodative monetary policy is well known. President George H. W. Bush's salvos against the Fed were so frequent and irritating as to damage Fed-Treasury relations. And most recently, President Donald Trump joined this august club of presidential monetary meddlers, albeit in a less-dignified fashion. Writing in the Wall Street Journal, Alan Blinder, a highly accomplished academic economist and former Fed vice chair, commented on how

Mr. Trump began his war on the Fed with a barrage of verbal abuse- berating the central bank, and [Fed chairman] Mr. Powell in particular, as "going loco" and being "the only problem our economy has." He made it clear that he regretted appointing Mr. Powell as chairman. But as my mother taught me when I was a kid, "Sticks and stones can break your bones, but words can never hurt you." So Mr. Trump turned to sticks and stones. First, he threatened to fire Mr. Powell, which he plainly lacks the authority to do. Then he threatened to demote Mr. Powell to being an ordinary member of the Federal Reserve Board (his previous position), not chairman. That, too, is almost certainly illegal. (2019) President Trump certainly abjures playing by Marquess of Queensberry rules, to put it mildly. Twitter is among his favorite media for expressing outrage. One such tweet, from June 2019, reads (in part): "The Fed Interest rate way too high, added to ridiculous quantitative tightening! They don't have a clue!" Again, although these remarks are unique in their manner of expression, elected officials--especially presidents--trying to pressure monetary policy makers is nothing new and in fact has been an informal feature of national politics for decades. However, the response to this pressure from the class of financial elites and macroeconomic philosopher-kings in the Fed has been unprecedented. In answer to President Trump's behavior, former New York Fed president William Dudley published an article in Bloomberg that comes dangerously close to suggesting the Fed should use its power to influence the 2020 election. Because "Trump's reelection arguably presents a threat to the U.S. and global economy, to the Fed's independence and its ability' to achieve its employment and inflation objectives," Dudley wrote, the Fed ought to "consider how their [sic] decisions will affect the political outcome in 2020" (2019). Apparently political pressure is a double-edged sword!

This situation is obviously concerning to those who care about macroeconomic stability and the rule of law. Political feuds between the White House and the Fed have the potential to spill over into other areas, causing both economic and political--especially constitutional--damage to the American republic. While President Trump's uniquely bellicose personality is surely part of the explanation for this newest stage in the conflict, there is a deeper, institutional aspect to it as well. The Fed has more power than it ever held before; therefore, being able to influence its behavior, whether formally or informally, has become more important. The Fed acquired an array of new monetary, financial, and regulatory powers as a result of the 2007-8 crisis. More than a decade after that crisis, it still has not normalized its balance sheet. The Fed has seemingly shifted to a new monetary policy framework, away from the "corridor" system in which it affected interest rates by participating within the market for loanable funds and to a new "floor" system that uses its ability to pay interest on excess reserves and thus allows it to treat interest rates like policy levers (Mueller and Wojnilower 2016; Beckworth 2018; Plosser 2018; Selgin 2018; Jordan and Luther 2019). And spurred in part by the new literature on "macroprudential" policy (Bernanke 2011; Hanson, Kashyap, and Stein 2011; Lim et al. 2011; Galati and Moessner 2013), the Fed is exercising ever-greater control over the financial system, without any meaningful increase in accountability.

This should make us cautious when discussing the seemingly rosy performance of the U.S. economy since the 2007-8 crisis. A slow recovery eventually gave way to what appears to be economic health: record low unemployment, minimal inflation, and booming financial markets. (1) But this apparent vigor is a facade. Because the Fed has transitioned from a precrisis regime of ordinary monetary policy (traditional openmarket operations) to extraordinary monetary policy (the floor system in conjunction with credit allocation), we cannot rely on the typical macroeconomic indicators to give reliable information regarding the strength of the economy. Because the monetaryinstitutional regime has changed, what we can justifiably interpret from economic data has changed as well (Goodhart 1975; Lucas 1976). Given the massive expansion in the Fed's balance sheet, combined with the interest-on-excess-reserves policy, we should not be surprised at the resulting "paper boom"!

The nature of Fed control over the U.S. economy is monocentric (Salter and Tarko 2017, 373), by which I mean it is consolidated, unitary, and hierarchical. Institutions of this kind are subject to several governance problems. First, as nonmarket entities cut off from the epistemic benefits of the market process (see Hayek 1948; Mises 1949), they have a difficult time acquiring die information they need to fulfill their mandate, which in the case of the Fed is full employment and price stability. Second, due to the lack of accountability mechanisms mentioned earlier, such institutions do not always confront the right incentives to serve the public as they ostensibly should. Because of these problems, it can be argued that not only is the Fed failing to live up to its mandate, but it is also becoming a positive danger, both to economic vigor and to democratic self-govemance.

Call the political-economic malaise the Fed has created malignant monetary monocentricity. How can it be cured? The surest way is with a complete institutional overhaul. In order to eliminate the malignancy, we must eliminate the monocentricity.

In its place should be a monetary system that is polycentric: fragmented, overlapping, and concurrent (V. Ostrom, Tiebout, and Warren 1961; E. Ostrorn 2010; Aligica and Tarko 2014; Aligica, Boettke, and Tarko 2019; for monetary polycentricity specifically, see Salter and Tarko 2017, 2019). Unlike monocentric systems, polycentric systems institutionalize a partly cooperative, partly competitive architecture that generates information and aligns incentives. Because of this architecture, they are able to meet governance challenges that monocentric systems cannot. And because they disperse decision-making authority more widely, they are compatible with a social ethos of democratic self-governance as well.

I organize the remainder of this paper as follows. In the first section, I expand on the information and incentive problems that all but guarantee monetary monocentricity will be malignant. In the second section, I outline the features of a healthy monetary system governed in polycentric fashion. In the third section, I broaden the analysis beyond economics, showing why monetary polycentricity is important on democratic grounds. And in the fourth section, I conclude by arguing that monetary' monocentricity, as a failure of both theory and practice, ought to be decisively and permanently rejected.

Monetary Monocentricity: Symptoms of the Disease

Malignant monetary monocentricity entails insuperable information and incentive problems. These problems are die reasons for monetary monocentricity's malignancy. Because of the consolidated, unitary, and hierarchical nature of our monetary system, it is incapable of governing the economic system in a way that is both macroeconomically effective and democratically fair, an incapability' that entails serious negative consequences for society at large.

Let us begin with information problems. F. A. Hayek (1948) identified the essence of this problem. The knowledge necessary to bring about widespread economic coordination is dispersed throughout society and does not exist in a manner that renders it useable by a single entity. Furthermore, much of this knowledge is tacit and local; it is not objectively communicable in any meaningful sense but is relevant to economic decision making nonetheless. How do economic actors in a market economy cope with this situation? The...