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April 2020 Issue [Revision]

The Money Question

Is Trump right about the Fed?
Illustration of Jerome Powell by Ricardo Martínez

Illustration by Ricardo Martínez


The Money Question

Is Trump right about the Fed?

Donald Trump likes low interest rates, and he doesn’t hesitate to let the world—or, more to the point, the Federal Reserve chair, Jerome Powell—know about it. “The Fed is raising rates too fast,” Trump told Fox Business Network shortly before the 2018 midterm elections. “The only problem our economy has is the Fed,” he tweeted soon after. Powell, in Trump’s analysis, is “clueless” and suffers from a “horrendous lack of vision.” On Twitter and elsewhere, Trump has publicly flirted with demoting or firing the Fed chair if he doesn’t get the message, and he has privately suggested that Powell wants to “turn [him] into a Hoover.”

Trump’s ongoing influence campaign has been widely treated as another egregious example of the president’s wanton disregard for long-standing norms—in this case, the protection of monetary policy from the exigencies of electoral politics. Last August, Powell’s four predecessors—Paul Volcker, Alan Greenspan, Ben Bernanke, and Janet Yellen—jointly proclaimed that the Fed must be free from political interference, so that its decisions can be “based on the best interests of the nation, not the interests of a small group of politicians.” Nancy Pelosi has said that Trump’s treatment of Powell is “very, very wrong,” and Senate Democrats have considered legislation to protect the Fed’s sovereignty.

The notion of absolute Fed independence is as old as the institution itself, but the historical record on the matter is complicated. In fact, the question of whether, and to what degree, the Fed should be insulated from elected officials has been a source of controversy from the institution’s very founding in 1914. When it comes to influencing monetary policy, Trump differs from his predecessors mostly in the openness of his efforts. What’s more, Trump has a point: throughout its history the Fed has tended to be too hawkish on inflation, and this tendency has led to economic suffering for millions of Americans—people to whom the Fed is not held answerable as other decision-making bodies in the federal government are.

This very lack of democratic accountability feeds a mystique, a sense that our central bankers deal with concerns that are above the comprehension of mere mortals. The Fed employs a large staff of highly trained professionals whose skills provide them exceptional insight on technical questions. This expertise makes Fed employees well equipped to reach judgments about setting interest rates, but—as has been demonstrated time and again—it does not prevent them from making mistakes. History tells us that the Fed does its best work when its relationship with elected officials provides some measure of political responsiveness.

The idea of creating a central bank first gained currency following the Panic of 1907—a severe financial crisis and economic depression that revealed the weakness of the nation’s banking system. Depressions like this one were then all too common, and advocates of a central bank claimed it would prevent such disasters in the future by lending banks extra reserves during emergencies. By the time Woodrow Wilson entered the White House, in 1913, establishing such an entity topped the political to-do list. Bankers of the time—sounding much like today’s Fed leadership—were emphatic that any central bank must not be “susceptible to political influence,” and the administration’s initial legislation was tailor-made to please them, granting banks both ownership of the proposed Federal Reserve System and a place on its governing board.

This arrangement severely troubled William Jennings Bryan, who served in Wilson’s cabinet. Bryan remained strongly identified with the “money question,” having risen to national prominence in 1896 after his “Cross of Gold” speech attacked the gold standard and won him the Democratic nomination for president. During the central bank debate, Bryan spoke for the many ordinary citizens who thought that bankers should not be awarded a role in the Federal Reserve’s supervision. This coalition of farmers, workers, populists, progressives, and other reformers believed that bankers already possessed undue economic and political influence, and opposed granting them any additional power. They agreed with Bryan that a Wall Street “money trust” already exercised excessive control over the distribution of money and credit.

The “Great Commoner” Bryan insisted that money must “be controlled by officials responsible to the people, and not by financiers, who would be tempted to act for their own interest rather than the interest of the public.” Because Wilson worried that Bryan’s political influence could scuttle efforts to establish the bank, he conceded that bankers should not serve on its governing board. Bryan then became an ally, smoothing the law’s enactment by taking the administration’s side even when critics in Congress pushed for more sweeping banking reforms.

This accord between Bryan and Wilson created the twelve separate Federal Reserve Banks that operate today. Bankers run these regional hubs, and their stock is held by the privately owned banks that are members of the Federal Reserve System. The seven individuals on the governing board who preside over the system as a whole are appointed by the president and confirmed by the Senate to terms of fourteen years. Five bankers serve alongside the seven governors on the Federal Open Market Committee, which regulates the nation’s money supply. Contrary to notions of Fed independence, its peculiar private-public hybrid structure is in fact an artifact of political compromise.

The Fed was originally viewed as a lender of last resort that would come to the aid of faltering banks by providing them with necessary liquidity. The idea that it should administer the money supply to manage the broader economy began to emerge only after World War I, once its leadership became aware of the impact their government-bond purchases had on interest rates. Yet the Fed’s handling of monetary policy soon grew into an undertaking of vast importance to all Americans. By adjusting interest rates through the purchase and sale of government securities, Fed leaders determine when to stimulate growth and when to throttle back the economy. The stock market, price levels, wage growth, and unemployment rates all follow accordingly.

In 1920, the Fed raised interest rates precipitously in response to inflation. Farmers already grappling with reduced European demand for food after the Armistice—and a corresponding fall in commodity prices—now struggled under the rising cost of credit as well. Within a year, the entire economy had sunk into a depression. Bryan held the Fed responsible for the severity of this downturn, lamenting that it “had been captured by Wall Street.” (Sharp downturns can yield boom times for bankers if they don’t drag on for too long.)

Meanwhile, farms were foreclosed on and unemployment surged. Agriculture and labor leaders protested that the Fed was subservient to bankers, a charge that was echoed in the halls of Congress. One senator sought to bar bankers from serving on the Fed’s governing board. This outcry persuaded the Fed to reverse course, and the depression was brief. Still, Congress concluded that the Fed could benefit from a broader point of view and added an additional member to its board—one who would specifically represent the interests of farmers.

Over time, the Fed’s leaders acquired greater skill in wielding their monetary tools, but they remained particularly concerned about the specter of inflation. (Whether in the 1920s or today, bankers perpetually deplore inflation because it eats away at the value of their financial assets: when bankers lend money at fixed rates, inflation makes the money they are repaid less valuable than the money they loaned.)

Economics textbooks use the 1970s to recount a cautionary tale of how high inflation can combine with low growth to produce national “malaise.” At that time, most central bankers came to believe that only a shock could bring the inflationary spiral under control. Paul Volcker made this objective a reality as chair of the Federal Reserve Board following his appointment in 1979. Under Volcker, the Fed hiked interest rates to record highs. As a consequence, economic activity fell sharply. The resulting recession was the worst Americans had experienced since the 1930s.

In Secrets of the Temple—a landmark account of Volcker’s reign at the Fed—William Greider observed that the “recession, perverse as it seemed, actually increased the profits of banking.” High interest rates attracted foreign investment, pushing up the value of the dollar against other currencies, making American products more expensive in comparison with imported goods and less affordable to consumers overseas. As a result, the unemployment rate surpassed 10 percent in 1982, and conditions were even worse in manufacturing and agriculture. Unemployment in areas of the country that depended on the steel industry rose to Depression-era levels, while the percentage of Americans living on farms fell by close to a third over the course of the 1980s. Meanwhile, bank profits shot up nearly 20 percent during the recession. If the allocation of economic resources is a political act, then the Fed is unquestionably a political institution. Some benefit from its decisions and others lose.

Those who warn of the danger of undue political influence on monetary policy rightly cite the example of Richard Nixon and Fed chair Arthur Burns. Facing reelection in 1972, Nixon was determined to send the economy into the stratosphere. He advised Burns that “goosing” economic growth was the proper course of action. On multiple occasions, White House staff communicated this message to Burns. Nixon even floated the possibility of doubling the size of the Fed’s board, which would have diluted Burns’s influence. This ongoing campaign of presidential intimidation yielded the desired result. Despite an overheating economy, the Fed held down interest rates, and growth surged in 1972. The following year saw soaring inflation, an OPEC embargo on oil, and the onset of a recession. Nixon’s short-term electoral calculus had longer-term economic consequences for the American people.

Yet some of the Fed’s most successful periods have occurred when its leaders deliberately worked in concert with elected officials. While many Depression-era bankers became apoplectic at the mere mention of Franklin Roosevelt’s name, Marriner Eccles, the Utah banker who led the Fed in the 1930s, backed the New Deal’s efforts to use government spending to spur economic recovery. He believed that monetary policy should lend a hand to the fiscal stimulus that the White House and Congress had endorsed. Unemployment fell under the New Deal and—aside from the brief recession of 1937–38—economic growth was strong. And during World War II, the Fed again backed the agenda of elected representatives, as Eccles used the bank to help finance the war effort, by aiming to keep down the cost of government borrowing.

The prosperous 1950s was another period when a presidential administration coordinated efforts with the central bank. Although Dwight Eisenhower claimed that “it would be a mistake to make [the Fed] definitely and directly responsible to the political head of state,” he thought the institution should always know his administration’s position on economic policies, so White House economic advisers established regular meetings with the Fed’s leadership. Rather than rebuff the administration’s input as an attempt to violate its independent status, these central bankers let guidance from democratically accountable officials shape their decisions. This partnership between fiscal and monetary policy helped keep inflation low and recessions mild.

The tenure of Fed chair Alan Greenspan, more than any other, explodes any notion that Fed officials operate apart from politics. A onetime devotee of the anti-democratic novelist Ayn Rand and the former director of J. P. Morgan & Company, Greenspan used his platform at the Fed to advance a comprehensive economic agenda of globalization and fiscal austerity. He kept interest rates low during the 1990s, and in return the Clinton Administration prioritized eliminating the deficit. In spite of the booming economy, austerity reigned as public investment in infrastructure, education, health, and other social goods declined. Throughout his tenure, Greenspan was a cheerleader for finance, pumping liquidity into the banking system when markets slumped, declining to puncture the massive late-1990s stock-market bubble, and promoting the financial deregulation that set the stage for the economic crisis of 2008. He followed the example of previous chairmen by expressing himself freely on economic policy questions, advocating Social Security benefit cuts, pushing the North American Free Trade Agreement and permanent normal trade relations with China, and playing a pivotal role in the campaign for George W. Bush’s 2001 tax cuts.

Though many of Greenspan’s own policies—such as his opposition to regulating the risky derivatives that contributed to the 2008 financial crisis—proved dangerously myopic, the justification given most often for Fed independence is still that the American people cannot take the long view. Increased democratic accountability, the argument goes, would result in shortsighted policymaking. The public’s relentless clamor for good times now would bring unchecked inflation. Yet when Americans confronted the sole inflationary spiral since the Fed’s founding, in the late 1970s, most identified it as the nation’s number-one economic problem, and a majority favored a recession if that was what it took to bring a stop to escalating prices.

This was hardly the first time that the public had sought to counteract rising prices. In 1946, when businesses lobbied to end the price and rent controls that had held inflation at bay during World War II, as many as 80 percent of Americans advocated maintaining the Office of Price Administration that managed these controls. “Inflation Today—Depression Tomorrow,” was among the slogans that motivated the women, consumer activists, labor-union members, and African Americans who led the campaign to extend price controls. “But alas,” writes historian Lizabeth Cohen in A Consumer’s Republic, her study of mass consumption in the postwar era, “a vote of Congress, not a plebiscite, determined the OPA’s fate.” While most ordinary citizens don’t share the bankers’ traditional view of inflation as a dragon to be slain at all costs, they have repeatedly recognized the threat it can pose to purchasing power and economic growth.

Despite the Fed’s fallibility, it remains worryingly unaccountable. The government’s most powerful economic regulator operates beyond the standard checks and balances that define democratic governance. At the same time, the Fed’s unique structure shields its leadership from public scrutiny. Funding from the Fed’s financial assets eliminates any need for federal appropriations and the congressional supervision this process involves; transcripts of Federal Open Market Committee meetings are embargoed for five years; and the Fed’s unelected leaders are further insulated by their lengthy terms. A critical outgrowth of this arrangement is that too often Fed policies have emphasized what is best for the financial community, rather than for the broader public.

Unlike the Fed, the White House and Congress are judged at the polls. Yet voters are not able to thoroughly evaluate the economic performance of these elected officials, because the effectiveness of tax and spending policy is contingent on monetary policy. Back in the 1960s, Representative Wright Patman—often called the last Texas populist—protested that the Fed’s autonomy created a harmful separation of fiscal policy from monetary policy that was “like a dual-control car driven by two drivers, one of whom insists on his independent right to use his own brakes and accelerator as he and he alone sees fit.” If elected representatives exercised greater oversight of the Fed, closer coordination of national economic policy would be possible. While these officials lack the training to directly set interest rates, voters do elect them to manage the nation’s economic affairs, including spending and taxation. Responsibility for overseeing the Fed and reviewing monetary policy logically falls under this same mandate.

Placing money within the realm of democratic control would bring a broader perspective to bear when decisions about adjusting the money supply are made. Raising the price of money is a crude tool that doesn’t have the same impact on everyone. Sales clerks, factory workers, and truckers lose their jobs when interest rates go up, not bankers or CEOs. Using increased unemployment to combat inflation has enormous social costs. Greater congressional review of monetary policy decisions would result in greater sensitivity to the social costs of job losses. Alternative methods for adjusting the money supply—taxation, price controls, wage guidelines, and voluntary campaigns to reduce consumption—are currently out of favor, but making the Fed more responsive to the American people would provide new incentive to explore more humane ways of slowing down the economy.

A direct line runs from the diminishing bargaining power of workers over the past forty years to the rising economic inequality that defines today’s second Gilded Age. When the Fed raises interest rates, job creation declines, and the ability of workers to obtain their fair share of economic growth is undercut. A monetary policy that is accountable to working people would likely be less accepting of unemployment and more tolerant of potential inflation. This is always a balancing act, and Americans deserve to have their voices heard when the time comes to make these tough calls.

Since the 2008 financial crisis, there’s been growing public awareness that these important trade-offs are decided outside the democratic process. Hence recent proposals to make board members of Federal Reserve Banks presidential appointees, mandate Government Accountability Office audits, make Federal Open Market Committee meeting transcripts available sooner, reduce the terms of Fed governors, and adjust those terms to align with election cycles.

Trump’s running attacks on chairman Powell could have an unexpected consequence: voters who are more engaged with Fed policy. In the end, only a well-informed electorate can make monetary policy the people’s business.

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