MYOPIC MONETARY POLICY AND PRESIDENTIAL POWER: WHY RULES MATTER.

• Author: Dorn, James A.

Independence is central to the Federal Reserve's ability to choose policy actions that achieve price stability. Sacrificing much of its independence, as the Fed often has, permits others to pressure the Fed to achieve other objectives, usually short-term objectives. That is one reason that the Fed responds to short-term events often at the cost of failing to achieve longer-term objectives.

--Allan H. Meltzer (2013: 405)

The Fed's Vulnerability to Political Pressure

In the absence of a monetary rule, a central bank is vulnerable to politicization. In the case of the United States, Congress delegated monetary authority to the Federal Reserve in 1913 and has increased the scope of that authority over time, especially following crises. However, Congress has never enacted an explicit rule to guide Fed policy, and it has used the Fed as a scapegoat when things go awry.

By law, the Federal Reserve has a triple mandate to "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." In doing so, the Federal Open Market Committee (FOMC) is instructed to "maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production" (Section 2A, Federal Reserve Act). (1) That congressional mandate, however, is a weak reed upon which to rest sound monetary policy in a world of government fiat money not subject to any enforceable monetary rule.

In 1978, the Humphrey-Hawkins Act required the Fed to set targets for monetary aggregates and report those benchmarks to Congress twice a year. There was no penalty if the FOMC failed to hit its targets, but the Fed would have to explain why (P.L. 95-523, Sec. 108 (a)). The reporting requirements expired in May 2000 and the Fed no longer pays much attention to the money supply. Instead, the Fed's main policy instrument since the mid-1980s has been the fed funds rate (i.e., the overnight rate at which member banks lend to each other). (2)

This article examines the relationship between Fed policy and presidential power in a fiat money regime in which Congress has delegated significant power and discretion to the Fed. By making the Fed responsible, but not accountable, for achieving full employment and price stability, Congress can shift blame to the Fed when it fails to meet those objectives. In their study of the political history of the relationship between the Fed and Congress, Binder and Spindel (2017) argue that the relationship is one of "interdependence" and that Fed independence is a "myth."

The fact that Congress has given the Fed increased power and discretion means that Congress is evading its constitutional duty to safeguard the value of money and, at the same time, opening the door for presidential jawboning. As Robert Weintraub, staff director for the House Subcommittee on Domestic Monetary Policy from 1976 to 1980, argued: By sanctioning "short-run money market myopia"--that is, lowering the short-run policy rate by expanding the money supply--"Congress weakened its own hand in supervising monetary policy and strengthened the hand of the Executive." Moreover, "money market myopia fitted harmoniously with administration concerns about financing the government's deficits" (Weintraub 1978: 359). He concluded that, without a credible monetary rule, "the President's objectives and plans will continue to be the dominant input in the conduct of monetary policy" (ibid.: 360).

Consequently, in the absence of a credible/enforceable rule, money supply targets are insufficient to overcome presidential ambitions to push for accommodative monetary policy, keeping rates low to finance deficits and stimulate production, at least in the short run. Of course, a strong leader in the White House could push for sound money, as did President Eisenhower; and a strong leader at the Fed, such as Paul Volcker, could do likewise.

For the last 25 years, from President Clinton through President Obama, criticism of Fed policy has usually been in private. But there has been a sea change with President Trump, who has been highly critical of Fed Chairman Jerome Powell for raising rates in 2018, especially the December increase in the target range by 25 basis points to 2.25-2.50 percent (see Smialek 2019). With tensions rising between the White House and the Fed, and with the Fed examining its strategy, tools, and communication practices, it is a good time to take another look at Fed "independence," the relationship between the Fed and president, and the case for a monetary rule to guide Fed policy and reduce the uncertainty inherent in a discretionary government fiat money regime.

Legally, the Fed is independent, but in practice that independence is continuously tested by political pressures for using accommodative monetary policy and credit allocation to win votes. An examination of the evidence reveals that presidents tend to get the monetary policy they desire. The adoption of a rules-based monetary regime could help limit interference in the conduct of monetary policy and improve economic performance.

Fed Policy and Presidential Power: An Uneasy Relationship

In considering the relationship between the government and the Fed, Allan Sproul (1948), then president of the New York Federal Reserve Bank, distinguished between "independence from government and independence from political influence." Most people, he said, accept the idea that the Fed should be held accountable by the government/Congress. However, from a narrow political viewpoint, "The powers of the central banking system should not be a pawn of any group or faction or party, or even any particular administration" (quoted in Meltzer 2003: 738).

That sentiment was recently endorsed by Fed Chairman Jerome Powell when he stated:

The Fed is insulated from short-term political pressures--what is often referred to as our "independence." Congress chose to insulate the Fed this way because it had seen the damage that often arises when policy bends to short-term political interests. Central banks in major democracies around the world have similar independence [Powell 2019: 1].

History, however, does not bear out this view of Fed "independence." The fact is that, in a purely discretionary fiat money regime, with little congressional guidance, the door is open for presidential power/jawboning to influence Fed policy. We have seen that in the past and see it now.

In his monumental History of the Federal Reserve, Meltzer (2003, 2010a, 2010b) provides ample evidence that monetary policy is not free from political influence. Likewise, Cargill and O'Driscoll, in their review of that history, and based on Ferrell's (2010) diary of Arthur F. Burns, conclude:

The Fed was appropriately constrained by fiscal dominance in both great wars. It was independent under the modified gold standard in the 1920s because of a rule. It gained operational independence after the 1951 Accord, but lost that independence starting with William McChesney Martin in the early 1960s and especially Burns in the 1970s. Paul Volcker and Alan Greenspan reestablished de facto independence in terms of focusing on price stability with an implicit adoption of the Taylor Rule. It has surely lost any meaningful independence under Ben Bernanke [Cargill and O'Driscoll 2013: 431].

It is well known that President Truman continued to pressure the Fed for low interest rates after the 1951 Accord. He disliked Fed Chairman Thomas B. McCabe, who was adamant about ending the pegging of U.S. bond rates and was pressured to step down shortly after the Accord was signed (Meltzer 2003: 712). His replacement, William McChesney Martin, became the longest serving Fed chairman (1951-1970). He believed in Fed independence and survived in office under five presidents by largely following their preferences. For example under President Dwight D. Eisenhower, the Fed pursued a stable money policy with low inflation and moderate long-term interest rates. But under President Lyndon B. Johnson, the Fed was pressured to pump up money growth and achieve lower short-run interest rates.

In October 1955, Martin gave his famous "punch bowl speech," in which he argued that the job of the Fed was to take away the punch bowl (i.e., slow money growth and raise interest rates) when the economy was at peak performance. (3) In that speech, he emphasized the importance of an independent central bank and the limits of monetary policy.

In framing the Federal Reserve Act great care was taken to safeguard this money management from improper interference by either private or political interests. That is why we talk about the over-riding importance of maintaining our independence.... While money policy...