Monetary policy rarely makes for eye-catching headlines. October, however, was an exception. In October, President Trump pinned the blame for the recent stock market slowdown on the Federal Reserve and Fed Chair Jerome Powell, who Trump himself appointed in February. He specifically slammed the Fed’s decision to continue gradually raising interest rates to prevent what Trump himself has touted as the “Best Economy & Jobs EVER” from overheating.
“I think the Fed is making a mistake,” Trump said to the press corps. “They’re so tight. I think the Fed has gone crazy.” In a later interview with Fox News, he reiterated his disappointment. “The Fed is going loco, and there's no reason for them to do it. I'm not happy about it.”
Trump and the Fed
Of course, this is far from the first time President Trump has expressed himself in an uncharacteristic manner. It’s not even the first time he has taken direct aim at the Fed. In September 2016, then-candidate Trump said then-Fed Chair Janet Yellen should be “ashamed” of herself for “doing what Obama wants her to do”—namely, keeping interest rates low to help boost Hillary Clinton’s election chances.
Trump broke the first unwritten rule of monetary policy: sitting presidents should never openly criticize or undermine the Fed.
The reason these particular comments drew the ire of economists, however, is that by directly criticizing the Fed, now-President Trump broke the first (and perhaps even second) unwritten rule of monetary policy: sitting presidents should never openly criticize or in any way undermine the Fed, much less with such brazen rhetoric. Even Yellen, as far from a spotlight seeker as former Fed chairs come, spoke out against Trump’s remark, saying: “It is not a desirable thing for a president to comment explicitly on Fed policy.”
Trump’s foray into being an armchair economist might have been ill-advised. But despite the outrage many media pundits expressed over his remarks, this is far from the first time a sitting president has acted in a way that might undermine Fed independence.
The real lesson economists should convey from this recent episode is that, if anything, Trump’s smack talk is small beans compared to the actual politically-motivated interventions into monetary policy many of his predecessors have taken.
The Fed Has Never Been Independent of Politics
The late economic historian Allan Meltzer made a career out of documenting the complicated relationship between the Fed and the federal government over the past century. His research makes it clear that despite recent protestations to the contrary, the Fed has never been independent of politics.
By 1951, Fed independence had been so compromised by the Treasury that the two sides agreed to return control over monetary policy to the Fed.
Any notion that the Fed would be independent was shattered within the first few years of its existence. During World War I, Congress strong-armed the newly created Fed into buying war bonds to help finance the war effort. The Fed’s willingness to accommodate the debt triggered our highest inflation rates since the Revolutionary War.
During the Great Depression, FDR didn’t hesitate to assume greater control over monetary policy. He repeatedly lobbied Congress to grant him greater authority over monetary policy as part of his controversial campaign to devalue the dollar and move toward a managed currency. Executive Order 6102 made it illegal for the public to hold gold coin, bullion, or notes. The Gold Standard Act of 1934 officially devalued the dollar from $21 an ounce to $35.
The Fed again accommodated wartime deficits during and after World War II, buying up billions of dollars in government bonds to peg interest rates. By 1951, Fed independence had been so compromised by the Treasury that the two sides agreed to return control over monetary policy to the Fed.
We Promise Not to Meddle Until We Do
Despite the passing of the Treasury-Fed Accord, political tinkering with the Fed accelerated during the 1960s and 1970s. The Kennedy, Johnson, and Nixon administrations each pressed the Fed to help finance the deficits that resulted from the Vietnam War and Great Society programs. In his 1967 State of the Union Address, Johnson vowed to “do everything in the president’s power to lower interest rates and to ease money.”
It wasn’t until Paul Volcker’s tenure under the Carter and Reagan administrations that the Fed was able to achieve any sort of autonomy.
On the day of Arthur Burns’ appointment as Fed chair in 1970, President Nixon made an open appeal: “Dr. Burns, please give us more money!” (His remarks in private were even more damning.) In 1971, Nixon controversially ended the convertibility of US dollars into gold, formally removing the US from the gold standard by executive fiat.
In light of the sudden collapse of the gold standard and this overt politicization of monetary policy, it’s no shock that the 1970s saw some of the worst misery-index ratings in US history. Inflation soared to double digits, and unemployment remained high for much of the decade. As Meltzer noted, “political concerns weakened whatever independence the Federal Reserve had just at the time when an independent central bank was most needed.”
It wasn’t until Paul Volcker’s tenure under the Carter and Reagan administrations that the Fed was able to achieve any sort of autonomy from politics. The results of the Great Moderation speak for themselves. Unfortunately, the moderation came to a crashing halt in 2009 when Fed Chair Ben Bernanke and Treasury Secretary Hank Paulson worked together closely to ram through controversial bank bailouts. As Meltzer concluded, “...under Mr. Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury.”
Make Money Boring Again
Simply put, since the Fed’s inception in 1913, there has never really been a firewall separating money and politics. For all the highfalutin rhetoric of how the Fed is independent, politics has always found a way to seep into the Fed’s decision-making. At the end of the day, the Fed is a political animal. It was created by Congress, very much as a response to political pressure and special interests.
Framing its actions in as bland of terms as humanly possible is perhaps the one rule the Fed has most consistently stuck to over the years.
None of this is to say that the problem lies with any particular individuals at the Fed. The Fed is staffed by exceptionally bright, well-intentioned economists. And to their credit, its leaders have largely done an admirable job of setting their politics and personal interests aside when conducting monetary policy. But at the end of the day, they are still appointed by the president, confirmed by the Senate, and ultimately answerable to the same Congress that legislated it into existence a century ago. “Separation of Money and State” might be an admirable goal. But it is naive to suggest it is or has ever been a reality.
As a general rule, monetary policy is supposed to be pretty boring. The FOMC is notorious for releasing intentionally dry statements to avoid any hint of the drama it has experienced recently. Indeed, framing its actions in as bland of terms as humanly possible is perhaps the one rule the Fed has most consistently stuck to over the years.
So maybe the recent spotlight on the importance of central bank independence isn’t such a bad thing after all. After spending a century treating the Fed like a political football and ceding more authority to it to take emergency action during crises, it would be nice to see both sides of the aisle come together to reduce the influence of politics in money. But that is unlikely to happen so long as the Fed remains so powerful and exercises so much discretion.
Rules, Not Discretion
The spotlight might be enticing, but for the sake of our economy, it’s best that the Fed relegates itself to a quiet role on the stage crew.
The 115th Congress considered legislation that would mandate the Fed adopt an explicit rule. The Taylor Rule is one prominent example, but there are other options that might perform even better. However, the best way to get politics out of money and “Make Money Boring Again” would be for the Fed to impose a strict and transparent rule on itself.
Economists have long lauded the virtues of “rules” over discretion. Evidence from around the world reported by the Fed itself shows that nations with independent, rules-oriented central banks perform far better than their more politicized counterparts.
If the Fed truly wants to avoid the drama of politics, what better time than the present to make the move toward a rules-based approach? The spotlight might be enticing, but for the sake of our economy, it’s best that it relegates itself to a quiet role on the stage crew.