Friday , December 3 2021

Fed has risen too far above political control

“Fundamentally,” President Biden said as he nominated Jerome Powell for another four years as the world’s most powerful central banker, “we need stability and independence at the Federal Reserve.” He’s probably right about that. The problem is that the need for stability — and for avoiding shocks for the markets, and for independence — cuts across the desire to exert more democratic control over central banks. Far more powerful than it was ever designed to be, and critical in the fight against inflation, the Fed now transcends democratic control.
Powell’s decisions on inflation could decide the political fate of Biden and his party. And yet Powell’s inflation strategy seems to have been virtually irrelevant to Biden’s decision to re-nominate him. Not only that, but the only other candidate considered, Vice Chairwoman-designate Lael Brainard, has never failed to vote in line with Powell on monetary policy in the seven years they have served as Fed governors. If there were any significant differences between their plans for the future (the market, very questionably, assumed that Brainard would be less aggressive about tightening policy and raising rates), these were never given a public airing. In any case, over the the past three years, Powell has been as activist and dovish as it’s possible to imagine. It’s doubtful that Biden was able to hear two contesting views and decide between them, and certain that neither the electorate nor the legislature got to do so.
To compound the sense of institutional capture, Biden judged the risk of ratcheting up uncertainty so great that the only candidates he considered had already spent many years at the institution. He judged that any attempt to bring in “fresh blood” would have been too risky, and would have left the Fed looking like a partisan body. He’s probably right about this. But his judgment implies that the Fed is now so powerful that elected politicians cannot touch it. That is terrifying. It’s no surprise that the role of the Fed is one of many contemporary issues where the libertarian right and the populist left make common cause against the status quo.
The electorate gets to express, with its votes, an opinion on more or less every other aspect of economic policy — taxes, fiscal strategy, tariffs and the rest — but not on monetary policy. The chair of the Fed must be given freedom of action, but the key opportunity that comes once in each presidential term for elected politicians to set the direction of monetary policy has just come and gone, without any input from voters. That does seem hopelessly undemocratic. There is a counterargument. What some might call a more “democratic” institution, others would describe as “politicised.” One of the most influential macroeconomists of his time, Rudiger Dornbusch of the Massachusetts Institute of Technology, went so far as to say in 1999 that “there is no such thing as a responsible politician, democratic money is bad money.” He was talking about the creation of the European Central Bank, but he reflected the importance that central bank independence had taken on.
Independent central banking is a relatively new phenomenon. In the years after the war, the Fed had to keep rates low to ease the burden of war debts. In the UK, the Bank of England left crucial decisions on interest rates to the chancellor of the exchequer, an elected politician who also controlled fiscal policy until 1997. But central banking independence has taken on overwhelming importance as it is now the de facto replacement for the gold standard. After Richard Nixon loosed the last remaining tie of the dollar to gold in 1971, inflation took off. It came under control again only after the Fed under Paul Volcker aggressively proved its independence, hiking rates in a way few democratic politicians would ever permit. Ironically, Jimmy Carter, who appointed Volcker, suffered a landslide defeat because voters had lost trust in him to control inflation.

—Bloomberg

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