The Power and Independence of the Federal Reserve Peter Conti-Brown.
Even though the time-pressed NABE reader may jump to the final chapter on the reform proposals, the book is worth a more leisurely tour. In my reading, hardly a few pages went by without something memorable appearing, usually in the form of a great anecdote. While the reform proposals are quite provocative (more on this later), the book is meant to be provocative from the start. The cover includes a picture--but not the one you think. Instead of a photo of the imposing and secluded Fed building, located far from the White House and Capitol Hill, Conti-Brown offers a historical drawing of the Treasury Department building (adjacent to the White House). As Conti-Brown points out in his revised preface to the second edition, this is designed to remind the reader that the Fed's independence was not given at birth but developed over time in what he referred to as the "three foundings of the Fed." (2) While the Federal Reserve System began in 1913, and the Board of Governors and the FOMC were established in 1935 with the Banking Act of 1935, the Board of Governors was housed in the main Treasury building until 1937 and was not "really independent" until the accord with the Treasury was hammered out in 1951. (3)
1 Fed as Ulysses/punchbowl
Conti-Brown moves his argument along by using the "Ulysses/punchbowl" phrase as the traditional description of the Fed. "Ulysses" refers to his ship's sailors putting bees wax in their ears to avoid the dangers of the Sirens on their famous journey. The "wax in the ears" analogy was new to me, but was an easy way to remember how the Fed would like to be portrayed as nonpolitical technocrats, who cannot hear the (political) sounds and work unimpeded (and effectively, of course) on the job at hand. The "punchbowl" argument is known to virtually all NABE members from the famous remark by Fed chairman Martin in the 1950s that the Fed's job was to take away the punchbowl when the party gets too hot.
Conti-Brown argues the punchbowl argument is too narrow. This is not news to economists of course. The punchbowl refers to inflation-fighting and is something the Fed "does" every day. But economists would argue that the most important thing the Fed does is something they do very rarely, serving as the lender of last resort. The Fed's role in financial market regulation and supervision is important, but not as important as the first two--at least to us Fed watchers. (More on this a bit later as well.)
2 Fed independence: what's the big deal?
Conti-Brown spends the bulk of the book examining what independence means, using his training as a lawyer and a historian. (4) As an economist, I am not alone in thinking, "What's the big deal?" Economists think of independence as narrowly defined "policy independence" regarding freedom from White House and Congressional meddling in the setting of the funds rate (or, more recently, balance sheet policy). (5) Conti-Brown admits this but goes on and on about "independence" regarding the broader mission of overseeing the Federal Reserve Banks. I would argue Conti-Brown misses a very important point. Economists care more about narrowly defined "policy independence," because the importance of "independence" varies across time. When decisions must be made quickly during a crisis, the Fed needs to be able to maneuver quickly and this is better done with minimal oversight. (6) And independence is also important when the Fed is playing the long game, understanding that underlying inflation is sticky and changes slowly. For example, political pressure from LBJ may have made the Martin-led FOMC gun-shy about tightening further in the late 1960s. The inflation problem was not "fixed" until Volker arrived in 1979 and brought inflation back to 4% by 1984. Economists are much less concerned about independence when conducting banking oversight, which is rarely time-dependent. Economists usually conclude that this regulatory work can be done in a more collaborative fashion with other agencies, the White House, Congress, and other central banks.
3 Reformed Fed = better Fed?
Some of the Fed's "problem" with those outside the temple is of its own making. Why call the Fed's emergency guidance document the "Doomsday Book?" Do Congress and the White House, much less the public have a copy? Why call the Fed memo on reducing the role of the Reserve banks in regulating the largest financial institutions the "Triangle Document," and only disclose this document to selected reporters five years after its creation? One doesn't have to be Dan Brown to think that the Fed has a tin ear at times, and is inadvertently feeding the conspiracy machine.
With that observation aside, we can now move to the guts of the book--the proposed reforms discussed in Chapter. 11. The proposed reform making the biggest splash when the book was first published in 2015 was the argument the Reserve banks were "almost certainly" unconstitutional and should be eliminated. I have long believed that "good government" demanded that Reserve Bank presidents should be appointed by the president and voted on by the Senate. In any event, Conti-Brown hints that eliminating the Reserve banks would be difficult given their regional political power. He made his point using a very amusing anecdote about a plane flight taken by Dallas Fed president Richard Fisher with Southwest Airlines president and founder, Herb Kelleher. On the flight, Kelleher went on the plane's intercom to extol 1 the importance of Fisher and how much good the Dallas Fed is doing for everyone on the flight. In fact, former Minneapolis president Narayana Kocherlakota (2017), went out of his way to defend the value of Reserve Banks in a in a long review of Conti-Brown's book in the Journal of Economic Literature.
I found his arguments about making both the head of bank supervision and the international finance presidential appointments persuasive. In an opinion piece in the Wall Street Journal, Conti-Brown (2017) called the Fed's chief lawyer Scott Alvarez "the most famous man you never heard of." And Conti-Brown also pointed out that in most cases, especially during the Greenspan era, the substitute for the Fed chairman at many international central bank meetings was not the Vice-chair, or even a Governor (all presidential appointments), but instead the head of the Board's International Finance Division. Neither meets my "good government" bar.
This leads me to bring up the second major failing of Conti-Brown's book. The author does not address the consequences of his proposed reforms. Namely, if the Reserve Banks were declared unconstitutional (as he claims) and subsequently closed, would the outcome be better for society? (7) I think the answer is no. A more-centralized Fed may be less opaque, more accountable, and would have a more logical, understandable and delineated structure. It would also be less powerful and less independent. The Fed would even more be the "first among equals" when dealing with financial market stability concerns. When the financial fires are raging, do we really want the Fed to be arguing with the White House, the Treasury, other agencies, and the Congress about the location of the fire dose and whether it should be turned on? A reformed Fed might have to make uncomfortable decisions and stake out unpopular stands. I wish Conti-Brown had asked if his proposals would be a change for the better.
Conti-Brown, Peter. 2017. The Most Powerful Man in Washington You've Never Heard Of. Wall Street Journal, July 12, 2017.
Kocherlakota, Narayana R. 2017. The Decentralized Central Bank: A Review Essay on The Power and Independence of the Federal Reserve, by Peter Conti-Brown. Journal of Economic Literature 55 (1): 621-636.
Tarullo, Daniel K. 2017. Monetary Policy Without a Working Theory of Inflation. Hutchins Center Working Paper #33, Brookings Institution. October 2017.
(1) I argue "potentially" important because his book might help get reforms at the Fed passed by Congress. I discuss whether that is a good thing at the end of this review.
(2) I waited to review the revised edition, which included only a new preface. Even though the first edition is only 2 years old, some of the discussion seems quite dated. One would have enjoyed a pointed discussion on what a Trump-led Fed might look like.
(3) It is also important to note that the Banking Act of 1935 centralized the control of the Federal Reserve System with the Board of Governors. Location was also a function of the size of government, which exploded to fight WWII. As my father, a 36-year veteran of the Treasury Department, said, "I used to share the elevator with OMB."
(4) Conti-Brown does know his economics. While his Ph.D. is in history, one of dissertation advisers was Alan Blinder. To Conti-Brown's credit, he discusses Blinder as one of real "disappointments" at the Fed. A bit earlier in the book, he argues that Dan Tarullo, a lawyer by training, was the most influential Governor (not a Chairman) of the modern era. I would agree (For more on Tarullo's experiences, see Tarullo 2017). Lawyers are going to become much more important in the Trump Fed, making the Fed more like what it was prior to the late 1960s. As of this writing, two of the four members have law degrees (Powell, the new Chairman, and Quarles as vice chairman for regulation). Lawyers rule!.
(5) Thanks to Richard Clarida for helping me better understand this point.
(6) Prior to the Dodd-Frank reforms, the Fed enjoyed considerable leeway during a crisis because of the (in)famous "unusual exigent circumstances" clause in the Federal Reserve Act (Sect. 13(3) of the Federal Reserve Act). While the Fed needed to "consult" the Treasury, they did not have to deal (at least initially) with other agencies or Congress. Now it is not clear (at least to this writer) if the Fed could bail-out a single failing bank without at least an OK from the Treasury (which means the White House), the FDIC, or even Congress. I wonder if Conti-Brown thinks this kind of reform is a good thing or a bad thing?
(7) This is the old problem of counterfactuals. Even some politicians understand this. Barney Frank of Dodd-Frank fame once said. The problem in politics is this: You don't get any credit for disaster averted. Going to the voters and saying, 'Boy, things really suck. But you know what? If it wasn't for me, they would suck worse.' That is not a platform on which anybody has ever gotten elected in the history of the world.
M. Cary Leahey (1)
Published online: 4 January 2018
[mail] M. Cary Leahey
(1) Decision Economics and Department of Economics, NYU, New York, NY, USA
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|Comment:||The Power and Independence of the Federal Reserve Peter Conti-Brown.|
|Author:||Leahey, M. Cary|
|Date:||Apr 1, 2018|
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