FEDERALRESERVE The Evolution of Fed Independence BY STEPHEN SLIVINSKI oday there is a consensus Wars, Depression, and How monetary policy that a central bank can best Dependence T contribute to good economic When the United States entered and central bank performance by pursuing price stabil- World War I in April 1917, the Federal ity — and that it should remain inde- Reserve almost instantly became the autonomy came pendent from political forces. In the primary vehicle for financing the war case of price stability, this understand- effort. The main function of the Fed of age ing evolved over decades of experi- during those war years was to lend ence. The notion of independence of money to banks to purchase “Liberty the central bank was more difficult to Loans” bonds from the U.S. Treasury. fulfill. They loaned the money at a discount- The original conception of the ed rate — not coincidentally lower Federal Reserve System when it was than the interest rate on the war bonds created in 1913 was meant to continue — to entice bond purchasers. After the spirit of the “independent treasury the war, the Federal Reserve Bank of system” that existed in the pre-Fed New York remained the official era. That system assumed that the U.S. fiscal agent of the U.S. Treasury Treasury would store its gold and Department. assets in its own vaults lest it unduly In the post-war years, the Fed influence the markets for credit and busied itself with maintaining the money. Ideally, Treasury meddling in newly reconstructed gold standard. what passed for monetary policy at the Its missteps in the wake of the stock time was to be avoided. market of October 1929 contributed Yet for most of the first four to the impression that the Fed was decades of its existence, a lack of powerless. independence was characteristic of Political forces retained the upper the Federal Reserve. The hand of the hand in the economic upheaval of the executive branch of the U.S. govern- Great Depression. As economist Allan ment was ever-present when the Fed Meltzer points out in his began operations in November 1914. history of the Fed, monetary The 1913 act that created the Fed policy would basically be made the Secretary of the Treasury dictated by Congress and and the Comptroller of the Currency the White House between ex officio members of the Board. 1933 and 1951. For instance, In fact, the Treasury secretary after Franklin Roosevelt presided over all meetings in those became president in 1933 he early days. The Board did not have assumed emergency powers its own building — they held their that explicitly took the meetings in the Treasury building United States off the gold instead. standard. Congress would Thus, the evolution of monetary later that year mandate that policy cannot be understood without the Fed issue “reserve notes” an understanding of the changes not backed by gold. The Fed Although the Fed Board of Governors and personalities involved in the was forced to freeze its asset portfolio VERNORS moved into their own building in 1937, evolution of the Fed as an institution. and the monetary base was effectively their independence in monetary policy ARD OF GO Throughout much of its history, the determined by the Treasury. wasn’t established until 1951. The struggle for independence has often Additionally, the Federal Reserve headquarters was named the Eccles occurred in conjunction with changes structure as we know it today is a by- Building — after the former Fed : FEDERAL RESERVE BO : FEDERAL RESERVE chairman influential in achieving in policy — and these changes have product of the policy actions taken Fed independence — in 1982. OGRAPHY T tended to reinforce each other. during the Great Depression. Many of PHO Fall 2009 • Region Focus 5 them were motivated by a desire of policymakers to further afoot to persuade Snyder to accept a small increase in short- centralize control over monetary policy. When Roosevelt term interest rates. At that meeting, Sproul raised a went looking for a new head of the Federal Reserve Board, challenge: The FOMC “should not seek instructions” from he settled on Marriner Eccles, an assistant to his Treasury the U.S. Treasury. Eccles agreed and said that if the Fed is secretary. Yet Eccles told the president he wouldn’t take the “expected to survive as an agency with any independence job unless the Fed was reformed to give the Board more whatsoever [it] should exercise some independence.” power over the regional Fed banks. The 1935 amendment to President Truman was also willing to try to influence Fed the Federal Reserve Act modified the FOMC and Eccles policy. In early December 1950, he phoned McCabe at his became its chief. He would serve as chairman until 1948. home and urged him to “stick rigidly” to the pegged bond While the 1935 act took the Secretary of the Treasury and rates. “I hope the Board will not allow the bottom to drop the Comptroller of the Currency off the Fed Board, it didn’t from under our securities. If that happens that is exactly translate into a softer hand by the executive branch in mon- what Mr. Stalin wants.” etary policymaking. When the United States entered World To help smooth relations and try to persuade the admin- War II, the Fed became again a mechanism by which the istration to change their stance on the bond peg, McCabe government could more cheaply finance the war effort. In met with Truman and Snyder at the White House on Jan. 17, April 1942, the Fed announced a policy of cooperating with 1951. The chairman stated the concerns of the Fed and the the Treasury to keep interest rates low. By 1947, the Fed was meeting ended without a specific resolution. McCabe summarizing its “primary duty” as “the financing of military seemed convinced that their conversation would continue requirements and of production for war purposes.” In his behind the scenes at a later date. memoirs, Eccles even described his work during this period But the next day Snyder delivered a speech to the New as “a routine administrative job” as the Fed “merely execut- York Board of Trade in which he announced that McCabe ed Treasury decisions.” Alan Sproul, the president of the had agreed with the Treasury’s peg policy. This infuriated the New York Fed, lamented, “We are not the masters in our members of the FOMC. The minutes of the Fed meeting own house.” record that McCabe reported to his colleagues that he had made no such commitment. The Accord The Fed decided to fight back. At their January 29 meet- After the war, Eccles — worried about inflation — began to ing, in a challenge to the Treasury, the Fed allowed the price make strong statements behind the scenes to the effect that of the pegged government bond to drop. The action the Fed should no longer support the prices of Treasury prompted Truman to call the entire FOMC to the White bonds. The “peg,” as it was called, was the rule by which the House to apply some pressure the next day. It was the first Fed would buy up those Treasury securities if prices fell as a time a U.S. president had done such a thing. result of a sell-off. President Truman didn’t take kindly to the As Meltzer describes it, “The meeting with the president Fed’s new stirrings of independence and told Eccles that he smothered the conflict in ambiguity. Everyone seemed to would not be reappointed when his term as chairman was agree, but no one changed position.” Yet the FOMC mem- over in 1948. He was replaced by Thomas McCabe but bers also were confident that nothing said at the meeting stayed on the Board as vice chairman. could have been construed as an endorsement of the Yet many within the Fed, particularly New York’s Sproul, Treasury’s policy position. were worried about the loss of Fed independence. For the At noon on February 1, the White House released a press next two years, the Fed and the Treasury would cooperate statement that took the Fed policymakers by surprise: The but in a rather tense and uneasy way. While the Treasury Truman administration announced that the Federal Reserve bond peg remained mostly intact, the stage was slowly being Board had agreed to the peg policy. In his memoirs, Eccles set for a showdown. noted that if swift action was not taken , the Federal Reserve The spark that ignited the next consequential chain of would lose the independent status Congress meant it to have events was the Korean War which began on June 26, 1950. and “would be reduced to the level of a Treasury bureau.” Although the first year of that war was financed mainly by The fight for Fed independence also began to hone the tax increases, the Treasury Secretary John Snyder made no thinking of Fed policymakers about the nature of inflation secret of his department’s commitment to keeping the Fed and the consequences of pegging the interest rate of in the business of maintaining the bond price peg. Treasury bonds. By committing to a policy of buying those The FOMC had other ideas in mind. Still wary of infla- bonds when the price fell below an arbitrary level, the tion, Fed policymakers were eager to raise the short-term FOMC members began to understand that they were interest rate to reduce the money supply and stave off price expanding the money supply. Richmond Fed economist increases. That would also have an effect on government Robert Hetzel and former Board of Governors economist financing of debt — it would drive down the price of bonds, Ralph Leach suggests this marked an “intellectual water- which is always inversely correlated with the interest rate, shed.” “Gone,” they write, “was the self-image of a central and also increase the government’s cost of borrowing.