Monetary Policy

Hijacking the Fed

Federal Reserve in Washington, D.C. (jjgervasi/iStock/Getty Images)
It is democratically illegitimate and legally dubious for the Fed to engage in freelance activism.

In a recent New York Times essay, Professor Annelise Riles urges President Biden to “Go Big and Bold at the Fed.” She exhorts the administration to appoint a new Federal Reserve chairman and new members of the Board of Governors who will be “flexible and forward-thinking,” considering or embracing theories such as “feminist economics” and “environmental economic theory,” as well as causes such as “climate change” and “financial citizenship.” Out of context, a plea for heterodox thinking and open-mindedness might seem benign. But in context, it is part of a larger, ongoing political effort to enlist the Fed in progressive causes by getting the president to pick activist Fed leaders.

Personnel is policy, as the saying goes. Pick activist leaders and the Fed will become yet another American institution bitterly divided along partisan lines. But there are three problems. It is democratically illegitimate for the Fed to engage in freelance activism. The Fed has no legal right to do so. And the consequences of this partisan football would damage America’s economy and culture.

Start with the democracy problem. The Fed enjoys substantial independence from political control. No one — not the Department of Treasury, not the president, not Congress — can tell it to raise or lower interest rates. The chairman and governors are appointed to 14-year terms and can’t ordinarily be fired. The whole structure is designed to insulate the Fed from political pressure to inflate the currency — juicing the economy in the short-term (useful for presidents who want re-election) with disastrous long-term effects.

The Fed enjoys this level of independence precisely because it is supposed to be limited to technocratic, economic issues. If it were in charge of contested value judgments, the chairman and governors should have to run for election. That’s how modern democracies work: contested value questions belong to the people through their representatives, with carve-outs for technical issues of governance that require an expert hand. The Fed’s legitimacy depends on the fact that it fits into that carve-out; it must wield only expert authority over only a limited, technical domain. It is illegitimate in a democracy for the central bank to act as a freelance activist institution pushing a partisan agenda as an end-run around elected legislatures and executives.

The democratic deficit here is similar to the one courts have been facing for decades. Federal judges likewise enjoy substantial independence because they are supposed to be legal experts resolving legal questions. To the extent they have departed from that mission by taking on contested questions about societal values under legal cover, the result has been to politicize the judiciary, raise justified questions about democratic legitimacy, and make judicial appointments one of the most contentious issues in American politics. The same thing could happen — to some extent, is happening — to the Fed.

The law governing the Fed reflects this understanding of American democracy. The Fed has only the power that our elected representatives in Congress have given to it. In other words, there are statutes, principally the Federal Reserve Act, which delimit the Fed’s legal power. Under those statutes, the Fed has no clear right — no well-founded legal authority — to take on whatever political cause is the issue of the day. The Fed’s statutory power and duty is to maintain price stability and maximum employment. The Fed isn’t constrained by the “conventional thinking” of its current leadership, to use Professor Riles’s phrase. It’s constrained by law.

It’s not surprising that flouting democratic governance and the rule of law is a slippery slope. But this slope is really slippery. A Fed that “align[s]” its monetary policy “with larger national and social priorities” — an “unconventional” Fed that moves fast and breaks things in response to current social pressure and presidential demands — would implicitly require tearing down the long tradition of Fed independence.

What would be the consequences? The first is inflation: Chief executives have long pressed for inflationary monetary policy in the interests of short-term political gain. The next is a politically motivated Fed picking economic winners and losers without due process — disfavoring an industry during one administration, favoring it again in the next. That takes us to the third consequence: economic policy by whiplash. What’s good for the goose is good for the gander: If Democrats engage in activist appointments on one side now, Republicans will likely do so when they have the presidency. But what the Fed controls is monetary policy, and partisan football in that domain is particularly dangerous. Unstable monetary policy, swinging like a pendulum with each new presidential administration, would be disastrous for businesses’ ability to plan and therefore for American growth. It would be disastrous for households’ ability to plan as well: Ordinary Americans could never know whether their savings might be diminished by high inflation or their ability to buy a house dissipated by changing mortgage rates.

There’s a cultural consequence as well. One of the most unpleasant aspects of the current age of extreme partisanship is that politics seems to invade every aspect of American life. Whether it’s where one lives, the school one’s kids attend, the place one works, or the sports and music one enjoys, everything is political. The idea that different spheres of life might have their own internal logics, some of which are independent of politics or even a refuge from politics, is being destroyed by the tribal partisanship of a polarized era. Politicizing the Fed means that one more part of the fabric of American society will fall to this partisanship. That would in turn exacerbate some of the more troubling aspects of American society today, including polarization, distrust of government and experts, and growing disillusionment with elite control over core institutions.

Big picture: Partisans try to get undemocratic power centers such as the Fed or the judiciary to engage in activist politics when they don’t have the votes to win in the elected branches. That’s what’s really going on here. They pretend that their views of what the Fed ought to do with its power reflect a social consensus. But if there were such a consensus, they wouldn’t need the Fed: the policies they favor would be established by the elected branches. In fact, the policy preferences espoused in Professor Riles’s essay reflect the views of one powerful contingent of the American elite. Enacting them through the Fed represents a form of elite control in which the values of a ruling class are imposed on the people outside the democratic process.

The ultimate irony of this position is that it pretends an ultra-elitist agenda is democratic. Professor Riles casts herself as breaking up an old boys’ club with fresh-thinking people. But what she portrays as an “exclusive class of central bankers blind to its own limitations” is actually just economists trying to stick to economics, justly skeptical of social-justice projects pretending to be economic ones. Speaking as law professors, the larger pattern and risk here is one we’ve seen before. Politicization of the Fed could become the new judicial activism — the central-bank version of judicial activism — just as damaging to our economy as it has been to our courts.

Joshua Kleinfeld is a Professor of Law at Northwestern Pritzker School of Law. Christina Parajon Skinner is an Assistant Professor of Legal Studies and Business Ethics at The Wharton School of the University of Pennsylvania.

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