This is the second in a three-part series on Fed governance. The first is here.
In the first post in this series, I discussed some of the problems I see in the governance structure of the Federal Reserve Banks. At the Brookings event where I laid out some of these arguments, my respondent was former Philadelphia Fed President Charles Plosser, a prominent economist who provided a thoughtful and spirited defense of the current structure against my critiques.
It’s not surprising that Plosser didn’t think much of my proposal to make the Reserve Bank presidents essentially, in his words, “senior staff at the Fed.” (This is, by the way, not an entirely accurate but more or less fair characterization of my proposal.) Plosser made many arguments, but his main critiques were two: (1) my proposal would politicize the Fed, thereby hurting its independence; and (2) there is no problem with the current governance structure, whether from a policy or legal perspective.
First, independence. I have thought a lot about this question; indeed, my book, The Power and Independence of the Federal Reserve is almost exclusively about the Fed’s independence. In the usual retelling of Fed independence, it is a legal separation between the central bankers (in the Fed’s case, usually the Fed Chair) and the President for purpose of price stability. Now, my book challenges this account, to be sure, as something of a momentary consensus and historical revisionism of the 1980s and 1990s (and not, as is widely assumed, the product of a dramatic compromise in 1951 or as having deep roots in the 17th through 19th centuries).
But let’s take that conception of central bank independence as a given to understand how my proposal to put the appointment and removal authority over the Reserve Banks in the hands of the Board of Governors. If we take that standard definition of central bank independence, I frankly don’t understand Plosser’s critique. Under my proposal, there is no greater role for political participation in the formulation of monetary policy except by negative displacement. There is simply less role for bankers and their representatives. The idea behind central bank independence is not that banks should balance politics in the formulation of monetary policy; it is that technocrats should. Again, I’ve got different issues with this formulation of central bank independence, but Plosser’s argument that banker-dominated governance is necessary to insulate the Fed from politics simply addresses an outdated (by many decades) mode of thinking of central banking.
Perhaps more to the point, as I show in an article that is forthcoming here from the print version of the Yale Journal on Regulation, the mechanisms of independence are many and varied, not least the Fed’s extraordinary independence of the congressional appropriations process. And the empirical literature on central bank independence looks at any number of legal mechanisms for establishing independence from politics; banker control of some seats isn’t prominent among them. Fed independence, then, isn’t about increasing banker influence on the Fed’s decisions, but neutralizing political influence. If anything, I want to further insulate the Fed from political interference, from the regulated banks rather than the politicians. Surely the argument is not that politics is a trade practiced only by politicians.
The second argument is that this is a solution looking for a problem, that the Reserve Banks’ governance isn’t problematic from a legal and policy perspective. Legally, I think this is just incorrect (while I discuss briefly the legal and constitutional problems in the Brookings paper, the Yale article cited above goes into much more detail). Plosser argued at different times in the presentation that surely a legal defect would be addressed by courts or Congress. And anyway, he argued, because the Fed is “created by an act of Congress, . . . in some sense, it’s legal.”
In the first case, as I argue in the Yale article, this constitutional defect hasn’t been litigated because the courts have determined that no one has standing to press it. In the second, I don’t think this is how our constitutional system works. Congress is capable of passing unconstitutional legislation, and I don’t think we should adopt a Frost-Nixon definition of ipso facto legality.
But I agree that the legal issue is less important, in some sense, than the policy question, not least because the Fed’s structure isn’t like anything else the Congress has ever created and because we are unlikely to get a definitive conclusion from courts. But here, too, I’m not convinced that Plosser is correct, both in fact and, more importantly, in appearance. In appearance, as former New York Fed President and Secretary of the Treasury Time Geithner put it, the Reserve Banks’ governance optics are awful. It feeds the mythology of a banker-owned, banker-dominated system. As I said in my first post, these critiques give momentum to movements to significantly curtail the Fed’s independence.
And this is not merely a cosmetic problem. We cannot hold policymakers accountable in the political process—if we like them or we don’t—if they do not participate, even remotely, in the political process.
The journalist Justin Fox, author of the exceptional The Myth of the Rational Market, thinks I and others who worry about Fed governance should “get over it” (really, the title of his response to the Brookings event is “The Fed is weird. Get over it.”). I apparently didn’t convince Fox that the Fed’s conflicted, opaque, and arguably unconstitutional governance structure is worth our worry.
But his defense of the “weird” governance seems to me a non-sequitur. Fox argues that the Fed’s independence is at stake if we remove private bankers from its governance, the confusing argument I addressed above. And second, he argues that “having the Federal Reserve Bank presidents on the FOMC increases the diversity of opinion and economic methodology on the committee.” I find this even more confusing than the first critique. Before the recent departures of the presidents of the Minneapolis and Philadelphia Feds, nine of the twelve were PhD economists. Now, economists obviously are not a homogeneous group, but the idea that the current governance structure produces a valuable range of intellectual diversity that a more transparent structure would not isn’t at all obvious. I would think a centrally administered appointment system at the Board could be much more sensitive to intellectual diversity than the decentralized process that currently exists. (To be fair, Fox admits in this article and elsewhere that the FOMC is not strong on intellectual diversity: his short but excellent recognition of this reality from a year ago is called “How Economics PhDs Took Over the Federal Reserve.”)
Is governance a side show at the Fed? Should those of us who are concerned about it get over it and focus on other problems? I don’t think so. I agree that governance isn’t the issue likely to light up the campaign trail. But I do think having the right institutional design at central banks—and institutional design that insulates the day-to-day of monetary policy from the day-to-day of electoral politics without compromising the democratic and constitutional requirement of accountability—isn’t a side show. It may in fact be the whole show. We can argue to the point of exhaustion about any number of aspects of Fed behavior and policy. Until we get a better ability to comprehend the Fed’s governance structure—who wield which powers, and to what end—I’m not convinced we will make much progress.
For the last installment in this series, I’ll turn to the recent WSJ article that shows that the Fed’s internal governance went through a radical change five years ago, but only fully reported this week.