SPRING 2021 C. Skinner, Independence: Executive Pressure and Central Bank Activism May 29, 2021 Christina Parajon Skinner, University of Pennsylvania – The Wharton School It’s now fashionable in some quarters to view central bank independence as quaint and out-of-date. Independence casts the central bank in the role of Ulysses, tied to the proverbial mast, thus capable of sticking to its commitments against all sorts of siren calls. But some might prefer a central bank that is more open to adaption and, in turn, more responsive to the major economic issues of the day. This tension is not new. President Andrew Jackson used a populist rhetoric to rally Congress and the citizenry against the Second Bank of the United States—a precursor to today’s Federal Reserve. To be sure, independence can insulate a central bank from pressure to act in ways that might seem modern, adaptive, and socially responsive. But it’s far from clear that eroding independence to seek such ends would carry benefits that outweigh the costs. I’ll first consider how we should think about the Fed’s ‘independence’ when framing its costs and benefits, and then examine whether it is independence at the root of this present-day dissatisfaction, or if, instead, contemporary complaints about independence are more accurately characterized as frustration with the rule-of-law. Independence: A norm, not a legal construct It is commonplace to refer to the Fed as “independent.” But what makes it so? There is no grand declaration of independence engrained somewhere in the Federal Reserve Act. Rather, the Fed’s independence is an amalgam of legislative bulwarks, principles of administrative law, and Fed-Treasury convention, all designed to insulate the institution and its leaders from popular and presidential pressure. Pressure to do what, you ask? Pressure to deploy the Fed’s policy tools or balance sheet to advance objectives on the Executive’s agenda but for which the central bank has no clear legal mandate. Independence, on this view, is a norm and not a legal construct. The norm may seem ephemeral but it is highly visible when lost. Inflationary pressure Historically, the Fed’s independence from the Executive Branch receded during wartime—to accommodate the government’s financing needs—and also when particular Fed leaders seemed too ready to appease. Consider a few key examples. In 1935, Congress reduced the role of the Treasury in the Fed’s affairs by removing the Treasury Secretary from the Fed’s Board and moving the Board’s physical office outside the Treasury building. The Fed knew this was important to its success. As then Fed Governor Marriner Eccles underscored for Congress, “if it is felt that the Federal Reserve Board is a political board and will be dominated by political expediency, let us say, rather than public interest, in monetary policy, then, certainly, there should be some changes.” Nevertheless, the Treasury pressed the Fed to “hold the cost of debt down” during and immediately after World War II. After the war ended, the Fed felt trapped and unable to maneuver to counteract inflation. Years later, after significant political drama between Fed Chair Thomas McCabe and Treasury Secretary John Snyder, the Treasury agreed to release the Fed from its de facto obligation to provide accommodative financing of the government’s debt in the so-called Fed-Treasury Accord of 1951. As formal statements of independence go, the Fed- Treasury Accord is a sacred text of sorts. But it did little to prevent future Presidents from intruding on Fed independence. During the 1960s, when Fed Chair William McChesney Martin wanted to raise the discount rate President Johnson “erupted”—“He demanded to know how the Fed and the Treasury ‘would guarantee that the higher rates [would] not hurt the economy’ . [1] When Martin eventually increased rates, the President commanded Martin to his ranch in Texas lecturing him, “[M]y boys are dying in Vietnam, and you won’t print the money I need.” Johnson probably would have fired Martin for his ‘infractions’ if the Attorney General at the time hadn’t told him that “termination for cause did not include disagreement with administration policies, and that in the Fed’s fifty-one years of existence no attempt had ever been made to remove a sitting Fed governor.”[2] The Fed’s independence teetered under the Nixon Administration as well. It is now well known that Nixon pressured Fed Chair Arthur Burns to run an expansionary policy that would aid his Administration’s popularity. In just one example, a December 10, 1971 tape records Burns reporting to the President, “I wanted you to know that we lowered the discount rate . got it down to 4.5 percent”—to which the President replies, “Good, good, good . You can lead ‘em. You can lead ‘em. You always have, now. Just kick ‘em in the rump a little.” Social pressure While these examples revolve around accommodative monetary policy and hence pressure to accept inflation, Executive Branch pressure today looks different. As I’veargued elsewhere, the Fed now faces pressure to actively evolve its tools in order to address new social policy problems that rank high on the Executive agenda. Climate change is the signature issue in this regard. The President has Ordered a whole-of-government approach to “climate-related financial risk.” In this vein, Treasury Secretary Janet Yellen has identified climate change as “an existential threat to our environment” and, as such, “a tremendous risk to our country’s financial stability.” Through the Secretary’s leadership on the Financial Stability Oversight Council, the Treasury can influence the issuance of nonbinding policy recommendations to the Fed, including, for example and in theory, some admonition to address climate change as a new financial stability risk. To the President and his Treasury Secretary, the Fed may well appear to be dragging its feet on climate change—hiding behind its independence. But, objectively, the Fed’s legal authority in this space is thin if it exists at all. Section 2A of the Federal Reserve Act gives the Fed responsibility for stable prices and full employment—anticipating and mitigating climate change does not fall within any colorable interpretation of that mandate. The Fed also has a duty, implied throughout the Dodd-Frank Act, to consider and mitigate risks to financial stability—but with big banks’ exposure to carbon-intensive industries weighing in at around 6% of their balance sheets or less (and in many cases, voluntarily declining), a climate- induced financial crisis seems still too remote to pass that statutory bar. Yet there is pressure on the Fed to act on climate. In realpolitik, maybe this is no surprise. The Fed is a remarkably effective institution with a powerful balance sheet. The ability to commandeer the institution toward certain presidential goals may well seem justifiable to those less concerned with legal mandates than end outcomes. The costs of eroding independence Still, one must wonder, do the proponents of the anti- independence view appreciate the costs of watering it down? If so, does broader society as well? Let me focus on just three. First, conscripting the Fed to address issues on the Executive agenda is inevitably a slippery slope. Once the Treasury puts the Fed in the business of, for instance, deterring banks from lending to “brown” companies, what sector might be identified for exclusion next by a future Administration? A President or Treasury Secretary that uses the nation’s central bank to starve financing from politically disfavored groups surely seems inconsistent with our republican form of governance. Second, and relatedly, such politicization of the Fed makes society much less stable. If the Fed’s policies shift from one Administration to the next, neither industry nor households can adequately plan. Suchuncertainty breeds economic anxiety, which could be socially destructive. Precisely to avoid such pendulums, Alexander Hamilton was careful to ensure the First Bank of the United States would not be overly responsive to the changing tides of popular or presidential opinion. As historian Paul Kahan has noted, Hamilton intentionally designed the Bank as “a hedge against the unpredictability of democracy.”[3] Third, and building on these last two points, does American society truly want a central bank Leviathan? There are many significant economic issues that are not problems for the Fed to solve—trade, immigration, tech disruption, economic relationships with China, just to name a few. In a non- command-and-control society, piling these myriad problems onto the remit of the central bank blurs the line between a monetary problem and one for another branch of government. Only Congress should assess the trade-offs Inasmuch as the gripe with independence comes down to central bank inertia, the anti-independence movement is, in fact, a quibble with the law. Thus, any solution must lie with Congress—not the President, the populous directly, or factions within the Fed. Only the legislature can legitimately engage in the kind of cost-benefit analysis required. Were the Fed’s independence to be modified or abridged, Congress would first need to consider and weigh the trade-offs. In the abstract, higher inflation might seem worth, for instance, greater income equality—and such pursuit worth undertaking. But inflation carries social and economic costs as well (inflation itself worsens inequality). Assessing those costs inter- generationally and across communities would demand data, projections, and—most importantly—subjective value judgments. Likewise, whether society is willing to accept the costs associated with consuming fewer fossil fuels today in favor of future generations is a question that only democratically responsive institutions should address. The U.K.: a comparative case study In the end, does any advanced economy genuinely wish for its central bank’s independence to be scuttled or suspended? As a closing thought experiment, it may be instructive to consider the law and practice of central bank independence in the U.K.