How much should the Fed have to say to Congress, and vice versa?
If you like street theater, Federal Reserve Chairman Ben Bernanke’s most recent appearances before Congress furnished plenty of it.
Senators and representatives took their turns lecturing Bernanke on the dangers of excessive expansion of the money supply. Bernanke warned them that while long-term fiscal balance is critical, moving toward it too fast would slow the economy. And he urged them specifically to extend the temporary reductions in the payroll taxes that fund Social Security, noting that letting this lapse would cause significant "fiscal drag" on economic growth this year.
Though I agree with his positions, I think that Bernanke is making a mistake by getting into congressional business. This may come back to haunt him, or his successor.
The principle that central banks should be insulated from political pressures if they are to succeed at maintaining price stability is an important one. But it is nuanced. The Fed, and its counterpart institutions around the world, were all created by government to serve public purposes, even if some – including the 12 Federal Reserve district banks – are legally private entities.
Central banks should and do have a responsibility to the citizens of their nations. Yet, history shows, when they are subject to excessive influence by executive or legislative branches of government, inflation is a usual result.
The U.S. Federal Reserve and the German Bundesbank long stood out in having a high degree of autonomy in comparison to the central banks of most other nations, even the post-World War II Bank of England. Over the last 30 years, however, there has been a move toward greater autonomy in many countries.
Within this legal independence of the Fed, there often is great variation in practice, especially in terms of how board chairs interact with the executive branch.
This interaction hit a shameful low point under the leadership of Arthur Burns, who before taking the Fed job had been considered a very distinguished economist. But Burns participated in the Nixon administration’s secret weekend meeting at Camp David that ushered in wage-price controls and U.S. repudiation of its contractual role in the Bretton Woods system of international payments.
The Nixon White House tapes show Burns frequently went to confer on monetary policy with Nixon and his aides, including explicit discussions of how alternative policies would influence upcoming elections. This was an area on which Nixon was particularly paranoid, believing that excessive Fed tightening had cost him the 1960 race against John F. Kennedy.
While Paul Volcker did consult periodically with presidents Carter and Reagan, he was a polar opposite to Burns in terms of guarding the Fed’s autonomy in monetary matters and in avoiding any consideration of the electoral implications of Fed policies. He eventually stepped down under pressure from Reagan aides who were concerned that the high interest rates resulting from the Fed’s anti-inflation stance would hurt Republicans in the 1988 elections.
Historically there was much less interaction between the Fed and Congress. Many in Congress felt the Fed was unduly independent. The 1978 Humphrey-Hawkins Act requiring biannual testimony by the Fed chair was their response. While this requirement has been modified, Bernanke’s testimony last week was a routine iteration in this practice.
While Humphrey-Hawkins was bad legislation in that it mandated conflicting and unobtainable goals for the Fed, the requirement for periodic reports from the Fed to Congress is a good one. A democracy’s central bank should be accountable for its actions in some way.
Yes, the Fed chair may have to endure public hectoring, but he and other governors don’t have to do anything Congress demands. The nation’s central bank still has autonomy in setting monetary policy.
So why is it a bad idea for the chair to lecture Congress on what it ought to do?
This is a question of nuance. The Fed is responsible for monetary policy. Congress and the president cannot tell it what to do. Congress and the president are responsible for taxing and spending. The Fed is not, and it should not tell them what to do. If it wants them to observe boundaries in monetary policy, it should itself observe similar boundaries in fiscal policy.
Yes, ideally the two should be coordinated, especially in times of economic peril. Yes, decisions by the Congress on taxing and spending create conditions that the Fed must deal with in its monetary decisions. Yes, if the Fed is trying to keep a sluggish economy from sliding back into recession and deflation, it would help if Congress passed legislation that worked in the same direction.
For the long-term autonomy of the Fed, however, some niceties need to be observed and scrupulous observation of policy-responsibility boundaries is an important one. The more directly the Fed tells Congress how to do its business, the more likely Congress will respond in kind. The more direct congressional pressure is, the harder the job of the Fed, especially in dicey economic situations.
Fed officials, including all the governors and the presidents of the district banks who participate in policy-making sessions, all can and do express their views in their frequent speeches in other venues. Wise members of Congress can be aware of those views and consider them in their own deliberations.
But Fed officials should not tell Congress to pass specific legislation. It was a mistake when Alan Greenspan voiced his support, however cautious, for Bush administration tax cuts and it is a mistake for Bernanke to weigh in on the payroll tax reductions.