The Federal Reserve met this month, upping its target for short-term interest rates. That we will return to the range of interest rates that prevailed for decades is about as noteworthy as the sun rising in the East. Yet the media and financial institutions focus enormous attention on the minutia of how and when that plays out.
Unfortunately, nearly everyone has been ignoring more important news about the Fed undergoing a de facto change in its relationship with the executive and legislative branches of our government. This change directly counters the intent of the legislation that set up the modern Fed 80 years ago and the practice followed by congressional leaders of both parties for 60 of those years. The new approach emerging now also directly opposes a broad consensus among economists on the best structure and governance of a central bank.
One element of this stealthy change is an increase in the ability of a president to influence Fed policy by naming members of the Board of Governors. The second is that committees in Congress, particularly in the House of Representatives, are attempting to directly issue orders to the Board of Governors on key issues. Both of these contradict policies set in place in the mid-1930s.
The historical background must be understood to evaluate what is going on now.
After the crash of 1929, it became clear that the Great Depression was so severe because the Federal Reserve failed due to its overly decentralized structure. This was 12 autonomous regional banks and a powerless board in Washington, D.C.
This decentralization had contributed to an unsustainable bubble in the late 1920s and neutered the Fed’s ability to counter the economic collapse after 1929. The damage was enormous.
The resulting revision kept basic structure of 12 banks. But changed the Board to seven members appointed by the president and confirmed by the Senate.
This board was to be free of politics. So the governors got staggered 14-year terms. No president could appoint a majority until the last year of a two-term presidency.
In practice, few governors wanted to serve 14 years. But regardless of the party occupying the Oval Office, nominees tended to be noncontroversial centrists. Early appointments had little practical effect on the board.
This bipartisan consensus ended in 1997 when Bill Clinton became wounded prey in the Monica Lewinsky affair. A GOP-majority Senate decided it would ignore Clinton’s appointments, leaving seats open for his successor.
So there were two open positions for George W. Bush to fill. Before the end of his first term, Bush appointed a majority.
Democrats played the same game with their brief Senate control at the end of Bush’s second term, giving Obama two open seats.
But the GOP upped the ante, refusing to consider an appointee for one open seat unless Obama’s nominee was paired with a Republican choice for the second. Later the GOP majority refused to consider Obama appointees to the last vacancies that appeared in the last half of his second term.
Combine that with a coming resignation of Daniel Tarullo and President Trump has three open seats. He can name a fourth less than a year. He will name a majority of the board after one year rather than seven.
Why does it matter? As long as presidents name competent, pragmatic moderates, no harm is done. But the framers thought policy continuity and insulation from politics warranted an elaborate structure. That now is a dead letter.
That would not matter if Congress clearly understood its proper relationship with our central bank. Some members clearly do not, as evidenced by extremely unwise letters sent by House committees to Janet Yellen.
One, from Patrick McHenry of North Carolina, vice chairman of the House Financial Services Committee, criticized the Fed for consulting with other central banks on monetary policy and bank regulation. The letter tells the Fed to join Trump’s program of reduced U.S. relations with other countries.
A second letter came from Jeb Hensarling of Texas, chairman of the committee. He ordered the Fed to stop ongoing rulemaking regarding banking supervision until the Trump administration has a chance fill a position. He further threatened that if the Fed does act, Congress will pass legislation overruling whatever it does.
Wise drafters of the Federal Reserve Act insulated it from political pressure, particularly that brought by a new president. Now the House is doing exactly what economic research and decades of experience in dozens of countries have taught us not to do. They are trying to make the Fed dance to the tune of politicians.
The U.S. dollar’s status as the globe’s primary reserve currency depends on continued world confidence in the autonomy of the Fed. There is 80 years of history, with some blemishes, of the Fed being an institution that takes its responsibilities seriously and capably. Only the German and Swiss central banks have the same level of public respect.
If presidents are able to pack the Board of Governors with sycophants, or if House committees dictate monetary policy or the details of financial supervision, confidence in the U.S. dollar will erode rapidly.
Having our currency be a medium of exchange and store of value for billions of other people may not be an “exorbitant privilege,” as some foreign critics claim, but, on the whole, we are far better off with the dollar as a respected and desired currency that as one viewed askance because we chose to flout wise legislation and sacrifice 80 years of sound precedent.
These letters from House committee leaders are imbecilic.
St. Paul economist and writer Edward Lotterman can be reached at firstname.lastname@example.org.