Fed Power

I think that, empirically speaking, the evidence that our independent Federal Reserve system works well is pretty strong. The current combination of deep concern about an economic slowdown in a presidential election year does, however, remind us of how much power has been concentrated in an office with little political accountability. After all, one huge factor in November's election is just going to be what decisions Ben Bernanke makes about interest rates over the next few months. Insofar as he's worried about the medium-term risk of inflation, that's good news for the Democrats.

Of course, putting the Fed under tighter political supervision doesn't do anything to solve this problem. Still, it strikes me as an under-remarked-upon feature of our political system.

Comments

It's under-remarked for obvious reasons. If you want to see what happens to a candidate who remarks on it, look at Paul.

Posted by Brett Bellmore | February 2, 2008 9:41 AM

One thing that makes it sustainable is that some of the stuff that other central banks do has been outsourced to below-the-radar-screen institutions. There is a larger monetary policy apparatus which is much less independent of the banking sector than the Fed itself.

Posted by P O'Neill | February 2, 2008 9:45 AM

Count me as the rare libertarian who thinks the Fed is a necessary evil and that it has done a generally good job over the last 30 years or so.

But putting it under more Federal regulation would undo all of that good and return the Fed to its earlier, less prudent days by placing it under more political pressure. That pressurse is bad enough as it is with relatively little government oversight, and I do fear that Bernanke has caved to it somewhat. But to have greater political pressure would be, I think, disastrous.

Posted by Mark | February 2, 2008 9:47 AM

I think interest rates do deserve to stay decidedly elitest affair. Think of Volcker back in the late 1970s. He knew he had to crank up rates to get inflation down; doing so caused Carter to lose, but he had to do it. If we had had a democratic debate about it, it would never have happened. When is it a good time to attack inflation?

Now, I do think some of the regulatory power of the Fed should be more scrutinized. Just because Greenspan (at the time) should have been allowed to set interest rates according the best information he and the board of governors had, he shouldn't have been allowed to become "Alan Greenspan," Olympian Economist, before whom Republicans and Democrats bowed on everything from the question of tax cuts and banking regulation; the former is none of his damn business (and, incidentally, something on which he was not a particular expert) and the latter is something the Congress ought to have more control over, in my opinion.

Posted by David | February 2, 2008 10:04 AM

"Thus the activities of the central bank acquire a quasi-
mystical power and authority that, in the view of most economists, make
money and the rate of interest the key to human welfare and the (uncertain)
economic outlook. In an economy dominated by uncontrolled finance,
economists persuade themselves, the public and governments that all is under
the influence of the money variables which the central bank is believed to have
under its control." ...Jan Toporowski

We used to have a labour economy instead of a finance economy.

Posted by bob mcmanus | February 2, 2008 10:08 AM

If anyone is interesting, I have more thoughts on Greenspan here:

http://sophistryandklatsch.blogspot.com/2007/12/alan-greenspan-oracle-of-delphi.html

Posted by David | February 2, 2008 10:09 AM

Just as its good to have a separation of church and state (something that is also "an under-remarked-upon feature of our political system") its also a good thing to have separation of politics and the financial system.

Perhaps the reason it is little remarked upon is because it works fairly well. So what should be the topic of the discussion - that politicians and political agendas should have more say in the financial system?

Posted by Ethel-to-Tilly | February 2, 2008 10:37 AM

The mortgage mess explained succinctly:

http://www.youtube.com/watch?v=BVv7Uz8nC2A

Posted by steve duncan | February 2, 2008 10:49 AM

The behavior that Presidents engage in with regard to the Fed is little remarked upon, but really is one of the benchmarks of performance in that office. Guys like Carter and Reagan were exemplary in this regard, whereas Nixon should have been impeached for the pressure he put on Arthur Burns (to say nothing of wage and price controls), which far exceeded Watergate in terms of damage done to society.

Posted by Will Allen | February 2, 2008 10:54 AM

Re Matthew's comment, the most "under-remarked-upon feature of our political system" is that we have an Athenian Democracy --

in which "the strong do what they will and the weak suffer what they must" while

Pericles McCain distracts the rabble with bullshit about national greatness.

Unfortunately, our Athens doesn't soak our foreign "allies" for tribute in order to create Partheon public works projects here at home -- quite the reverse, actually.

Posted by Don Williams | February 2, 2008 12:04 PM

"whereas Nixon should have been impeached for the pressure he put on Arthur Burns"

"White House officials have told us that President Bush intervened forcibly to convince an initially reluctant Federal Reserve to reduce interest rates. "There were some telephone calls from the White House to the Fed in which some very crude language was used."

Swoop, January 28th-February 3rd report

Posted by bob mcmanus | February 2, 2008 12:21 PM

If we get a repeat of the 70's, bob, and this report is true, Bush's behavior in this matter will be about the worst thing he's done, on a pretty long list.

Posted by Will Allen | February 2, 2008 12:40 PM

The Fed has not gotten very high marks for its policies in the last decade. Paul Volcker has been very critical. Joseph Stiglitz, a Nobel prize winning economist, has had unkind things to say as well.

"Easy Al" and "Helicopter Ben" have caved in to both Wall Street and political pressures (2 sources that are now indistinguishable) far too easily, and as a consequence always have chosen to sacrifice long term gain for short term expedience.

Greenspan was directly responsible for the current housing crisis, and his ever-changing, but always exculpatory, explanations are a study in poor CYA management.

Posted by kafka | February 2, 2008 1:31 PM

"I think interest rates do deserve to stay decidedly elitest affair. Think of Volcker back in the late 1970s. He knew he had to crank up rates to get inflation down; doing so caused Carter to lose, but he had to do it."

I think this kind of distorts the history. Keep in mind that the Fed Reserve Chair during all but the last year of Carter's administration was appointed by Republican Gerald Ford. They're appointed for 5 year terms and the President doesn't have any authority to remove him. It wasn't until 1979 that Carter had the opportunity to put his mark on the Fed and then he appointed Volcker, because he realized that the policies of the Republican appointed fed (which promoted inflation) were damaging the country. So if you're going to credit Volcker for anything, you also have to credit Carter.

Posted by mike | February 2, 2008 2:15 PM

"So if you're going to credit Volcker for anything, you also have to credit Carter."

I am happy to credit Carter. But that doesn't really change anything.

Posted by David | February 2, 2008 3:08 PM

What Brett Bellmore said. Note also that the Fed is trying to profit from money earned illegally.

Posted by TLB | February 2, 2008 3:25 PM

The fear of political interference on central bank policy is always that politicians will always call for ease. Ease can come in many forms not just rate or open market operations. It also includes reserve requirements, our now essentially zero, and regulation of the assets banks hold and the standards they use for lending. Perhaps those last two sound a bit familiar somehow, as well they should. For it was the lack of lending standards that lead to the current residential real estate mortgage crisis. Greenspan is directly responsible for those millions of foreclosures coming, among other sins to numerous to mention.

For 20 years the Fed couldn't have been more easy unless the did Ben's helicopter drops. If you don't think that was political then your a fool. Both parties embrace, and rude humping, of the sudden rate cuts by the Fed just show that the Fed is totally politicized. No use worrying about it happening, it happened 20 years ago.

"After all, one huge factor in November's election is just going to be what decisions Ben Bernanke makes about interest rates over the next few months. Insofar as he's worried about the medium-term risk of inflation, that's good news for the Democrats."

I don't have the time or space to unpack all the false assumptions included in that but the worried about inflation part is particularly funny. Oil is over $90bbl and wheat is near $10, I could go on. Inflation is here, big time. Not only that, the dollar is in record low territory and doomed to go lower long term. The Fed stopped worrying about inflation long ago. Or rather they assumed that the inflation would continue forever only in asset prices keeping CPI inflation in check. Those dreams are dashed yet in two weeks the Fed dropped their target Fed Funds rate into negative real territory. Inflation substantiation.

Our elites hope against hope that like in the golden days of the Maestro their assets will continue to inflate, or at least not deflate. That's all. They don't give a flying fuck if a meal at McDonalds costs $10 or a fill up $75. Make no mistake I indict the Democrats just as much as the GOP. More. For Clinton embraced this Wall Street paradigm of a finance centered economy which was a direct rejection of the core principals of the party post FDR.

By the way. The cuts won't work. They did reinflate the stocks of the financial sector, for a moment. Dream die hard.

Posted by rapier | February 2, 2008 4:09 PM

"I think that, empirically speaking, the evidence that our independent Federal Reserve system works well is pretty strong."

This from a guy who admits he knows nothing about economics and who talks about an "economic slowdown" when everybody else is screaming "RECESSION" and some analysts are even starting to use the "D" word...

Slowdown, right...

Yeah, you can say since we allegedly haven't had a "depression" since the 1930's, one could say it's "working well".

I haven't had a heart attack yet, so I must be healthy.

Right.

Posted by Richard Steven Hack | February 2, 2008 7:09 PM

Note also that the Fed is trying to profit from money earned illegally.

Give the Fed the power to trade in the open market (which is necessary to control interest rates and the money supply) and someone will believe that the Fed is trying to make a "profit" at the expense of the country. The reality, of course, is that the Fed doesn't give a crap if it makes a "profit". Its member banks are much more interested in the profits to be made through a sound economy than the small return on their shares in their local Federal Reserve Bank.

Posted by Dilan Esper | February 2, 2008 7:35 PM

The Fed acts in full view , without apology, to promote, enhance and insure bank profitability.

As originally conceived the Feds role was to insure the quality of bank assets and the level of it's reserves. .If a banks assets are good and cash reserves adequate it can hardly fail.

Soon, as was inevitable, it became more involved in the quantity of bank assets. As one would expect no quantity is ever enough. Relentlessly since the early 20s the Fed worked ever and ever and ever harder to increase bank assets. . The Depression was a severe blow to this but the task was successfully rejoined after WWII. Credit growth grew in a leisurely sustained way till 1982 when Morning In America was really launched, on credit. By the end of 06 the assets of the five great Wall Street behemoths was $1 trillion dollars and growing at a 25% annual rate. All in a $13 trillion dollar economy.

Bank assets consist entirely of credit extended, ie. debt.

Obviously systematic credit creation, debt, was growing at an unimaginable pace. Profits were equally astounding. Just one year later if you wanted to get picky, the worlds largest bank Citicorp is bankrupt. The quality of much of its assets cannot be determined. They are not tradeable and thus cannot be marked to market, There is no market for huge swaths of the CDO's created out of mortgages and receivables from all manner consumer and even commercial debt. . A bit of hyperbole there perhaps but essentially true if one wants to look at it in a light other than the one put forth in public by anyone in authority. . The manner that expresses some concern about the 'subprime' problem, which will be 'resolved' with lower interest rates.

The Feds reputation is still pretty much intact. Go figure.

Posted by rapier | February 2, 2008 10:38 PM

rapier:

The Fed's job is to produce economic growth and full employment while controlling inflation. All of its powers (such as controlling bank reserve ratios, trading securities on the open market, and setting interest rates) are deployed to control the money supply to fulfill those goals.

Whatever may have been the case in the 1920's, that is how the system works now and has worked for a few decades.

The Fed, in the main, only cares about "bank assets" to the extent that they are part of the money supply. Creating money through "credit", as you put it (i.e., by allowing banks to lend out a regulated percentage of their deposits), is only bad if it results in runaway inflation. That hasn't happened.

As for the securitization of mortgages, that isn't part of the Fed's portfolio. The SEC regulates the sale and purchase of such securities, and the claims made by brokers and sellers. Fannie Mae has some indirect and direct involvement in the creation of some such securities, though as far as I know not the ones that were the big offenders during this scandal. The Fed, though, really is not supposed to regulate the securities market; rather, the Fed trades in that market, not to manipulate it but to control the money supply.

The fact that the Fed is a quasi-independent agency allows a lot of conspiratorialists to believe the worst about it. The problem is, that stuff that they believe simply isn't true.

Posted by Dilan Esper | February 3, 2008 12:41 AM

I think that, empirically speaking, the evidence that our independent Federal Reserve system works well is pretty strong.

That's supportable. They've certainly learned many lessons since the great depression, which is exactly why we haven't had another great depression since, a very, very good thing.

But Milton Friedman was right. We need to replace the Governing Board of the Federal Reserve with rules which specify static Fed actions under certain economic conditions: if GDP growth is X or less in the previous year, the Fed does this, if GDP growth is greater than X in the previous year, the Fed does that.

Among other benefits, such a reform would completely eliminate any danger from the Fed interfering with politics by eliminating its ability to do so. For this very reason we should generally prefer rules over rulers in our political institutions.

yours/
peter.

Posted by peter jackson | February 3, 2008 1:09 AM

"The Fed's job is to produce economic growth and full employment while controlling inflation"

Well nothing like the impossible job. It's especially telling that the most enthusiastic Fed supporters are also free market fundamentalists who seem unaware that their use of terms like produce and control are antithetical to their core philosophy..

The paragraph starting "The Fed..... as written makes no sense. Could you please try again.

The securitized mortgages on and off, and then back on bank balance sheets are absolutely in the Feds purview because the Fed can stipulate the type and quality of the assets member banks hold. Not to mention Citi et al should never have been allowed to have off balance sheet assets. Not that Greenspan's Fed had any interest in using prudence and caution in regard to quality of said assets. Which is why several trillion dollars of them are going in the dumpster.

All this discussion misses an absolutely fundamental point which is that banks are no longer the primary supplier of systematic credit. Thus the Feds 'control' of money supply and all those things which they are supposed to 'control' through Policy and regulation is not in the 'control'.

Under their influence perhaps, but control no. Mostly that influence relates to the management of expectations. Mixed in with that was the repeal of New Deal banking laws and thus tearing down the tattered wall separating the banking side from the brokerage side of the Wall Street giants. The Fed, Greenspans Fed, and Greenspan, were crucial supporters of all that which we will now have the fun of seeing fall apart.

I have suggested no conspiracy nor do I mean to in regard to the Fed. A better smear will have to be used. I'm not against central banking nor fractional reserve banking or fiat money or a gold bug nor any of those other flavors of populist sentiment. Populist sentiments which are and have been far more prevalent on the right for 50 years, from John Birch to Ron Paul.

Posted by rapie | February 3, 2008 7:09 AM

Among other benefits, such a reform would completely eliminate any danger from the Fed interfering with politics by eliminating its ability to do so.

It would also interfere with the Fed's ability to do countercyclical monetary policy. Since there's no evidence that the Fed has been playing politics the last 30 years, I'd rather that it keep that power. (If suddenly there was a rash of politicized Fed decisions-- which was, as far as I know, a somewhat more common complaint when Friedman proposed that decades ago-- I might change my mind.)

Well nothing like the impossible job. It's especially telling that the most enthusiastic Fed supporters are also free market fundamentalists who seem unaware that their use of terms like produce and control are antithetical to their core philosophy.

rapie, I am not a free market fundamentalist. And most liberal economists I am aware of LIKE the federal reserve. In fact, it tends to be Ron Paul and Jude Wanniski and Milton Friedman types who don't like the system-- though some far-left conspiracy nuts don't like it either.

The securitized mortgages on and off, and then back on bank balance sheets are absolutely in the Feds purview because the Fed can stipulate the type and quality of the assets member banks hold.

What makes you think that banks were buying and holding most of the mortgage-backed securities?

All this discussion misses an absolutely fundamental point which is that banks are no longer the primary supplier of systematic credit. Thus the Feds 'control' of money supply and all those things which they are supposed to 'control' through Policy and regulation is not in the 'control'.

You don't need to control all the money to control the money supply. All you need to do is to be able to withdraw and inject funds into the economy. The Fed's tools (interest rates, open market operations, and reserve rules) work fine to do that.

Mixed in with that was the repeal of New Deal banking laws and thus tearing down the tattered wall separating the banking side from the brokerage side of the Wall Street giants. The Fed, Greenspans Fed, and Greenspan, were crucial supporters of all that which we will now have the fun of seeing fall apart.

Again, the SEC and Congress regulate securities. The Fed controls the money supply and has regulatory powers over banks that are tailored to that. "Wall Street" is in the purview of the SEC and Congress, not the Fed (except indirectly).

Posted by Dilan Esper | February 3, 2008 8:58 PM