The Pandemic Depression
The Global Economy Will Never Be the Same
Monarchs of old used to clip currency. Shaving slivers of gold or silver off coins was a crude but effective way to acquire seigniorage—revenue from minting money—which they often used to finance unpopular foreign wars. Nations don’t do that anymore; there aren’t enough gold and silver coins left to make a difference. Instead, they generate seigniorage by printing money to finance debt and allowing the resulting inflation to erode the value of the currency in circulation and, if the inflation surprises markets, to erode the value of the pre-existing debt.
Which brings us to U.S. President Donald Trump and his plan—now hastily modified—to put both Herman Cain and Steven Moore on the Federal Reserve’s Board of Governors. Trump has expressed extreme unhappiness—anger, even—over the actions taken by the politically independent Federal Reserve. He would like to clip its wings by placing sycophants like Moore (and, before he withdrew, Cain) on its board. Economists and businesspeople, almost to a man and woman, think this is a terrible idea.
To see why, look back a few decades to a time when U.S. presidents regularly sought to enlarge the budget deficit while persuading the central bank to keep interest rates low. Economists call that practice “monetizing the budget deficit,” and it tends to raise inflation.
In extreme cases, which the United States has thus far managed to avoid, monetizing deficits leads to hyperinflation; indeed, it’s hard to imagine getting the latter without the former. But even in more modest cases, it still tends to lead to higher inflation, and until fairly recently was practiced on a bipartisan basis by U.S. presidents. Lyndon Johnson tried to do it in the 1960s, but collided with Federal Reserve Chair Bill Martin. Richard Nixon, who had his own man, Arthur Burns, running the Fed, succeeded in doing it in the 1970s. Ronald Reagan made a rather lame effort to do so in the 1980s, but ran in to an immovable object named Paul Volcker.
To guard against the dangers of monetization, congresses and parliaments throughout the world have granted their central banks substantial independence on the grounds that non-political technocrats charged with keeping inflation at bay would do exactly that. Although the United States was pretty much the last advanced nation on earth to equip itself with a central bank (Alexander Hamilton’s idea did not survive Andrew Jackson’s presidency), it was in the vanguard when it came to granting its central bank independence, starting with the original Federal Reserve Act of 1913.
Sound monetary policy requires thinking for the long term—something not many politicians are known for.
Almost all economists think this was a wise move. Compared to politicians, technocrats can set monetary policies that are less subject to political manipulation, geared toward the long term, and informed by specialized expertise.
First, the politics. An independent central bank can and should insulate monetary policy from the extremes of political influence. As a candidate, Trump claimed that Fed Chair Janet Yellen maintained near-zero interest rates to further the political interests of President Barack Obama. As president, he has fretted that his own choice for Fed Chair, Jay Powell, has raised interest rates to damage his political prospects. He’s wrong on both counts. Each Fed chair did what the Federal Reserve Act instructs the central bank to do: pursue “maximum employment” and “stable prices.” And both have done the job well.
Sound monetary policy also requires thinking for the long term—something not many politicians are known for. Roughly speaking, analysis of the U.S. economy suggests that changes in interest rates take a year or two to have major effects on real GDP and employment levels, and then about another year to have major effects on inflation. Three years is an eternity in politics. But technocrats, who don’t have to stand for election, can afford to wait that long.
Finally, doing monetary policy well requires specialized expertise. If you are skeptical, try asking your member of congress why the Federal Reserve now uses the interest rate on excess reserves as a central tool of monetary policy, but did not do so before the financial crisis. (For that matter, try asking Moore.)
Virtually every economist and financial market participant, and even most members of Congress, believe that monetary policy decisions should be left to technocrats with insulation from politics, long time horizons, and serious expertise.
That said, the word “independent” has a sharply limited meaning in the context of the Fed. The Fed has no special constitutional protections; indeed, the Constitution makes no mention of a central bank whatsoever. Rather, it assigns the power “to coin money [and] regulate the value thereof” to Congress. “Regulating the value thereof” is what we now call monetary policy—an idea unknown to the Founders. In 1913, Congress delegated that authority to the new central bank it was establishing. The Constitution’s silence on the issue means that the Federal Reserve Act is an ordinary statute that Congress can amend any day it chooses. It could abolish the Fed tomorrow. (And this president, unlike most, would probably sign the bill.)
That would be a drastic step, but it illustrates an important point: the Fed’s powers, while substantial, are sharply limited. It was Congress, not Ben Bernanke, Janet Yellen, or Jay Powell, that assigned the Fed its famous dual mandate to pursue both “maximum employment” and “stable prices.” The law also severely limits the types of assets the Fed may buy and sell in pursuit of these objectives. Since 2010, even its ability to make emergency loans in a crisis has been curtailed (in what was probably a bad move).
The Fed’s vaunted independence from politics is also not absolute. All Federal Reserve governors, one of whom serves as chair, are nominated by the president and must be confirmed by the Senate. Once confirmed, however, they may be removed from office only “for cause”—for malfeasance, basically—not at the whim of the president. And, importantly, the Fed does not have to go to Congress for its annual budget.
All this adds up to a great deal of, though not absolute, independence from politics. Current law and Trump’s Fed appointments to date strike a delicate balance between politics and technocracy that is working well. Let’s not unravel it at the whim of a would-be monarch.