The rule of law or the rule of central bankers?

• Author: White, Lawrence H.
• Position: Essay

Economists often prescribe that countries seeking economic development should embrace the principle of the rule of law. I want to suggest that we listen to our own advice and apply it to our monetary and financial system. The principle of the rule of law could usefully guide us in resolving the extraordinary situation we have been in for the past two years or so, and even more importantly help us to avoid future crises.

The approach of Federal Reserve and Treasury officials during this crisis, unfortunately, has been to consider every possible remedy but applying the rule of law.

In case you think I exaggerate, let me quote Ben Bernanke. At a strategy meeting with other Fed and Treasury officials early in the crisis he declared, as reported by the New York Times: "There are no atheists in foxholes and no ideologues in financial crises" (Baker 2008). Over at the U.S. Treasury, when Neel Kashkari, the Treasury's chief bailout administrator under Secretary Hank Paulson, was asked by a reporter how the Treasury would spend the $700 billion in bailout money that Congress had provided (essentially without instructions), Kashkari replied that nothing was ruled out. To quote a news account: "'We are looking at everything,' he said. 'We are trying to figure out what will provide the most benefit to the financial system'" (Ellis 2008).

If we unpack Bernanke's and Kashkari's messages, here is what they were saying: "When we in authority declare that it is time to be pragmatic, then we can do whatever we please. There are no durable principles, no constitutional or statutory constraints, limiting what we may do once we declare an emergency. Our hope of avoiding a deeper crisis authorizes us to make it up as we go along, to do whatever seems expedient at any given moment."

Such sentiments are not surprising from men held responsible for the health of the economy--which by the way is an absurd assignment for any government to give, an absurd assignment for anyone to accept, and an absurd assignment for the rest of us to take seriously. Such men understandably want to avoid being seen as doing too little. Had Ben Bernanke stood on principle, he probably would not have been reappointed as Fed chairman by President Obama. (Someone more flexible would likely have taken his place.) What is surprising and disappointing is how many commentators ostensibly in favor of free markets and constitutionally limited government have echoed these sentiments.

The Rule of Law

References to the rule of law are rare in discussions of Federal Reserve policy. The concept of the rule of law in jurisprudence and political philosophy has several dimensions. At its core is the classical liberal principle of nondiscretionary governance that stands in contrast to the arbitrary or discretionary rule of those people currently in authority. In shorthand, either we have the rule of law or we have the rule of authorities. Under the rule of law, government agencies do nothing but faithfully enforce statutes already on the books. Under the rule of authorities, those in positions of executive authority have the discretion to make up substantive new decrees as they go along, and to forego enforcing the statutes on the books.

Friedrich Hayek in his classic work The Road to Serfdom contrasted "a country under arbitrary government" from a free country that observes "the great principle known as the Rule of Law." "Stripped of all technicalities," he continued, "this means that government in all its actions is bound by rules fixed and announced beforehand rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one's individual affairs on the basis of this knowledge" (Hayek [1944] 2007: 112).

It is of course true that laws must be executed by people in authority. We also know that the referees in a soccer match will be people (although robot referees would be cool). But they can either be people who impartially enforce the rules of the sport as they were known at the outset of the match--that is, who follow the rule of law--or they can be people who arbitrarily enforce rules against one team but not the other, or (even worse) who penalize a team for "infractions" of novel "rules" that they have made up in mid-match.

The rule of law concept has deep historical roots. Hayek else-where (1969: 118) quotes David Hume's History of England--written two centuries earlier--on the value of establishing the rule of law in place of the unconstrained discretion of government officials. Hume acknowledges that it is not always convenient in the short run to forego ad hoe measures. He writes that "some inconveniences arise from the maxim of adhering strictly to law," but affirms the lesson of history that in the long run we are better off from adhering to the rule of law. According to Hume, "It has been found, that ... the advantages so much overbalance" the inconveniences that we should salute our ancestors who established the principle.

The contrast between the rule of law and the rule of men is sometimes traced still further back to Plato's dialogue entitled Laws. In that work ([paragraph] 715d), the Athenian Stranger declares that a city will enjoy safety and other benefits of the gods where the law "is despot over the rulers, and the rulers are slaves of the law." In other words, government officials are to be the servants and not the masters of society.

The rule of law is vitally important because it allows a society to combine freedom, justice, and a thriving economic order (see Barnett 1998). When legal rules are known and government actions are predictable, free people can confidently plan their lives and businesses, and can coordinate their plans with one another through the market economy. Citizens need not fear arbitrary confiscation of their possessions or nullification of their contracts. Entrepreneurs know that if they succeed in turning lower-valued bundles of inputs into higher-valued products, they get to keep the rewards. If they fail, they fail, and they bear the losses.

The Rule of Central Bankers

What does all this have to do with avoiding and resolving financial crises? The rule of law...