Why Alan Greenspan should show you his hand.
Rep. Henry Gonzalez, the Texas Democrat, is proposing reforms to ensure that all senior Fed officials are presidentially appointed and congressionally approved--some Fed officers are now chosen by bankers--and that records of Fed decision-making be made public. These are reforms without friends in high places: President Clinton concurs with the conventional wisdom, saying there "is a general feeling that the system is functioning well and does not need an overhaul just now." In the following pages, the Monthly explains why Clinton is wrong.
The Federal Reserve and its conduct of monetary policy involve daunting complexities, but the most important thing to understand is really quite simple: The Federal Reserve is a political institution.
That is not how the Fed is generally perceived or depicted. By tradition and design, the conventional wisdom describes our central bank as a kind of cloistered sanctuary where disinterested experts make authoritative calculations about the future of the economy. The Fed's governors are said to be "above" politics--protected from the messy claims of special interests that surround Congress and the president. The extraordinary secrecy surrounding the Fed's decision-making supposedly insures that crass political motives will not intrude on its difficult deliberations.
The veil of secrecy certainly does enhance the mystique surrounding the Fed--and the general ignorance about it. Otherwise confident and intelligent people, including members of Congress, defer to the Fed's wisdom mainly because they do not understand it. They are understandably intimidated by its mystery and power.
What I found behind the veil, in the years of research that produced my 1987 book on the Fed, Secrets of the Temple, is an agency of mortal men and women--smart, dedicated, and exceptionally well-educated people who are empowered to decide some of the largest questions of how the federal government manages the economy. In my many interviews, the one theme that Fed governors, Federal Reserve Bank presidents, and other senior officials repeatedly emphasized was their own fallibility. Monetary policy is filled with large uncertainties, squishy facts, and unpleasant trade-offs between competing goals. The Fed deliberates at length, but it must also decide things on the run, since neither financial markets nor the broader economy of commerce will wait for its judgments.
And, as every Fed governor freely acknowledged to me, the Fed also makes mistakes--just like the rest of us mortals. The difference is that the Fed's mistakes can have devastating impact on the lives and fortunes of millions. It can sink viable business enterprises, force debtors to the wall, and put millions of people out of jobs. It can reward some investors and punish others. It can literally reverse the tide of economic growth or, in other circumstances, ignite the economic energies of the nation, not to mention the world.
Given these vast powers, it is fatuous to pretend that the Federal Reserve can somehow be insulated from politics. And, indeed, it is not. As any candid Fed govemor will tell you, the institution is bombarded constantly with pleas and demands and unsolicited advice from select interests. As a matter of style, lobbying the Fed is done more delicately and discreetly than, say, lobbying Congress or the White House, but the private and semi-private dialogues surrounding monetary policy go on continuously--between the Fed and financial markets, banks and brokerages, and other major players, both foreign and domestic.
The only players who are left out of this conversation are the American people--and, to a large extent, their elected representatives. Instead, they are provided a frustrating stream of evasive euphemisms, opaque jargon, platitudinous generalities, and, sometimes, even downright deception. As more than one Federal Reserve governor confided to me, it would be very difficult--perhaps impossible--for the Fed to have an honest discussion of monetary policy with Congress or the public because the level of ignorance (and the potential for misunderstanding) is so profound.
So, if Congress is serious about reforming the Federal Reserve, it will necessarily have to think about changing more than the institutional behavior of the Fed. The lack of accountability is not simply a function of Fed mystique. Among elected politicians, there is also a widespread willingness not to know or understand. In fairness to Congress, the news media encourage this deference by promoting the conventional wisdom about the institution. Any politician who dares to become a critic can count upon damaging attacks from both editorial writers and news reporters, accusing him or her of "political meddling" with the non-political Federal Reserve.
I want to be very clear about what I mean by "political institution." I am not arguing that the Federal Reserve plays partisan favorites at election time or that it secretly obeys the incumbent president's whispered commands. Those are the standard complaints of Fed critics, but I found them refuted again and again by the actual history of the central bank's performance. If the Fed was dedicated to punishing Democrats and rewarding Republicans, then George Bush might still be president, and Richard Nixon would certainly have defeated John F. Kennedy in 1960. If the Fed faithfully took instruction from the White House, Jimmy Carter might have enjoyed a second term.
I am using "politics" in its generic sense: The Federal Reserve makes large and potent public decisions backed by the force of government power--yet there are no reliable mechanisms for political accountability or even for achieving a decent public understanding of what has been decided in the people's name. The Fed's power over the daily lives of ordinary Americans--not to mention the largest enterprises of commerce and finance--is at least as great as the president's or Congress's and, in most instances, more immediate. It takes many months or years to enact new legislation or to redirect the priorities of fiscal policy. Monetary policy can turn winners into losers overnight, and vice versa.
The Fed never has to face reelection. It was designed that way, of course, in order to resist the transient storms of popular opinion or narrow partisan ambitions. The actual result, I think, is a skewed political process in which some citizens have a large voice and most citizens have none. Bankers are consulted regularly and intimately, but labor unions and farmers, home builders and independent oil drillers are not. The bankers have their own private policy meeting with the Board of Governors four times a year--and just try getting a transcript of those discussions.
My point is not that the Fed is "captured" by the bankers and bondholders, as some critics claim. The reality is more complicated. My complaint is that the Federal Reserve, given its own institutional biases, is preoccupied with a narrow version of economic reality while other competing versions are excluded from the inside debate. If we could actually hear the inside debate at the Fed, I think this distortion would become clear to most everyone.
Frankly, the Fed does not even have to confront intelligent scrutiny from those the people have elected to represent them--the Congress. In my experience, congressional oversight hearings are usually a dispiriting mixture of posturing and bile and trick questions that Federal Reserve governors find quite easy to fend off. It is hard to take most of the congressional questioning seriously and not surprising that many at the Federal Reserve do not.
Meanwhile, important decisions are made in private, and only the most sophisticated observers can read the portents. Wall Street spends big money on its "Fed watchers" because it needs to understand what the Fed will be doing to interest rates and the supply of credit and, therefore, to economic activity across every sector.
But the public is regularly blindsided by these government decisions because nobody will give it an intelligible explanation of what's coming and why. In fact, nobody looks backward in a patient manner and asks the most obvious questions: Was the Federal Reserve right in its decision? Or did the governors misunderstand the economic forces and choose the wrong objective? Did it make another large mistake? In financial markets, investors speak of "transparency" and they insist upon it before they will buy a company's stock. They need to be able to see inside the company-beyond its rhetorical claims--in order to judge the logic of the company's business strategy and the reality of its performance. The Federal Reserve lacks "transparency." There is no earthly way that an average citizen can parse meaning out of the Fed's dense pronouncements. And there is no practical way for any member of Congress to begin to exercise accountability. To understand the Fed's policy, we need to be able to see the arguments that produced it.
This is not an unreasonable standard. Every other institution of government--except perhaps the Central Intelligence Agency--is required to reveal itself in just these terms. A president or any executive branch agency must provide exhaustive documentation and rationale for decisions. Every member of Congress must literally contribute to a public record of argument and deliberation. That's the basis of accountability.
That is why Henry Gonzalez's reform proposal is so important. Among all of the various reform measures he proposes, one goes to the heart of the matter: A requirement that the Fed make public a full transcript of the deliberations of the Federal Open Market Com mittee (FOMC), the powerful body that decides monetary policy, two months after its meetings. This is a necessary first step--no more than that--toward developing a more mature understanding of monetary policy and, therefore, a reliable sense of accountability. Gonzalez's bill is actually quite modest in scope. It does not compromise the Federal Reserve's established independence in any way. It does not try to change the institutional structure of the Federal Reserve System.
It simply asks a very basic question of a powerful government agency: Tell us what happened at your meeting. Let us hear what you said in plain English. Let us see why you made these decisions, what you thought you would achieve, what the economic conditions looked like to you at the time. Given that information, then we might be able to judge more coherently whether you are doing a good job or not, whether the tradeoffs you chose seemed reasonable, given all the interlocking complexities--or whether the Fed has made a large mistake and ought to correct it.
Some have proposed that the FOMC be required to announce its policy decisions on the same day they are made rather than releasing a summary statement six weeks later. The Federal Reserve has always argued against immediate release on the grounds that it would weaken its ability to conduct monetary policy. I think the Fed is right about that. The Federal Reserve is an active daily participant in the credit markets--actually, the largest participant--and, like every other player, it develops its own trading strategy for the weeks or months ahead. This is the essence of the FOMC policy directives to the open-market desk in New York, which buys and sells bonds in the open market as the mechanism for controlling the money supply and interest rates. It makes no sense to compel the Fed to reveal its trading strategy in advance so that other traders can use the information to adjust their own portfolios. The bond traders might like that, but it wouldn't do a thing for the general public or for the Fed's effectiveness.
It is reasonable to tell the Federal Reserve to publish a transcript of FOMC deliberations two or three months after the fact. That is a long enough delay to avoid any complications for the Fed's open-market desk, but it is still timely enough so that outsiders can find the information relevant to the larger economic debate. The old reporting system--unilaterally abolished by then-Fed chairman Arthur Burns in the mid-1970s--provided only a secretary's rough minutes of the FOMC debate, and it wasn't made public until five years after the fact--too late to be of any use to anyone but scholars.
If Congress adopted this modest reform, what would the public get?
A hard slog through very turgid stuff, believe me. Based on my interviews with Fed governors recounting the internal debates and on reading through several years of old FOMC minutes, I don't think anyone will be taking this book to the beach. We would be required to read long, earnest, genteel, and quite dense arguments over economics. No name calling. No secret political plots. No heavy oratory. Once in a while, perhaps, we might find a remark that sounds like one governor heckling another for some prior misjudgment, but the internal criticisms are usually quite subtle. The Federal Reserve is a decorous institution--even behind closed doors.
The grist of these private discussions is about the competing analyses of the economy held by the people at the table--arguments over what is happening and how monetary policy will affect everything from bank lending and manufacturing to unemployment and retail sales. This material, in other words, is not likely to yield sensational headlines. But it would be extremely useful to serious people who are willing to spend some time and effort tracking the monetary debate, month after month, and then ask intelligent questions about it. This starts with Congress, presumably, but it might also include the wide array of economic sectors that are not in banking or finance but which feel the impact of monetary policy, from farmers to home builders. In short, releasing the record is a modest step toward public education and accountability.
Would it change the FOMC conversation around the big long table? Sure, at least a little. Any public official who knows his words are recorded is likely to talk a little differently than he might in private. But so what? The content of the debate inside the Federal Reserve can be its own educational tool, just as members of Congress use the floor debate for broader purposes than persuading colleagues. That's valuable in a democracy.
Would it change the Fed's decisions? Maybe. If it makes the people at the table more sensitive to the competing trade-offs and to the wider variety of economic interests that will be affected by their decisions, that is a valuable result, too. But it won't reduce the daunting complexities and uncertainties that Fed governors must confront. This is the nature of monetary policy, and no one can change that.
So why then do I think this modest reform would be so significant? Believe it or not, I actually think the simple step of casting some sunshine on monetary policy might make the Federal Reserve a more effective institution of government. It would certainly raise the level of the economic debate in this country. It could actually enhance the Fed's credibility with the general public as people get a better grasp of the hard choices the Fed confronts, and at least put to rest some of the spookier conspiracy theories that are now so popular.
It would also encourage Federal Reserve governors to share the premise of their decisions with the people at large in terms that ordinary people can understand. The Fed is often essentially warning folks to slow down, telling business or consumers or investors to temper their appetites and behave more prudently. That message can be communicated with more effective results if people know what the Fed knows and if people can grasp what the Fed is trying to tell them.
The larger consequence of this reform should affect other government decision makers far beyond the Federal Reserve--perhaps including Congress. Making monetary policy more visible and legible ought to improve the government's overall management of the economy--not to mention the quality of our democracy--because it would illuminate contradictions which at present no one has to face.
Wright Patman, the late populist congressman who once chaired the House Banking Committee, once referred to the existing arrangement as "a car with two drivers." By this he meant that the fiscal policy of spending and taxation is controlled by Congress and the executive, while the money and credit policy is controlled by the central bank. One driver has a foot on the gas, the other on the brake. These two levers interact powerfully with one another, and the results are sometimes contradictory.
Yet there is absolutely no requirement in the law that the two levers must be coordinated. There is not even an intelligent process by which monetary policy and fiscal policy can be viewed together as pieces of an overall economic strategy. We all hope that there are private conversations between the Fed, the White House, and the budget leaders of Congress. But they certainly don't match notes in public, and their plans are often in conflict.
Instead, each side is free to go its own way, regardless of the other. I suspect that, down deep, both sides like it like that: Neither Congress nor the Federal Reserve wishes to coordinate policy, even in the most limited fashion, because that might crimp their ability to do their own thing. Forget the larger fallout.
Here are some tangible examples of what I mean:
* In 1981, when Congress passed the Reagan economic program, the massive tax cuts and defense buildup were powerfully stimulative to the economy. But the Federal Reserve was simultaneously embarked on the opposite course: suppressing economic growth with extraordinarily high interest rates in order to squeeze out price inflation. Leave aside the argument over who was right and who was wrong. The stark fact is that the government was pushing the national economy in opposite directions at once. The car with two drivers wound up in a ditch--first a deep recession, then an awesome accumulation of debt--and we are effectively still in it.
* After the 1981-82 recession, though it never said so in public, the Federal Reserve privately resolved that it must continue to check the stimulus provided by the Reagan program in order to prevent inflation from recurring. In order to do that, the Fed held interest rates very high throughout the 1980s--the highest rates of this century in real terms--and that produced many collateral consequences:
1. The savings and loan crisis was dramatically worsened by the Fed's high interest rates. Fed Vice Chairman Preston Martin, who argued repeatedly and unsuccessfully for an easier policy to help salvage the S&Ls, told me: "We just threw them to the wolves."
2. The U.S. trade deficit ballooned from 1980 to 1985 because the Fed's tough monetary policy sent the value of the dollar soaring against foreign currencies. Privately, Paul Volcker anguished over this, but he did not change the policy. Lee Iacocca complained that once foreign producers grabbed market shares, it would be very difficult for American manufacturers to get them back. He was right. The trade deficit is with us still, despite a much weaker dollar.
3. The collapse of Third World debt in August 1982 was directly triggered by punishing interest rates--a connection denied at the time but now widely acknowledged by global financial authorities. Once the debt crisis put major American banks in peril, the Fed had no choice but to come to their rescue. Our trade relations with Mexico and the debate over NAFTA are directly tied to what the Federal Reserve decided 10 years ago. Does anyone in Congress examine the connection?
4. The farm crisis of the middle 1980s--and the debt liquidation of tens of thousands of family farms--was also linked to the Fed policy. The Fed, of course, did not set out to achieve this, but it was an inescapable side effect. When Paul Volcker's Federal Reserve doubled and tripled the cost of borrowed money almost overnight, it collapsed the collateral value of farmland and guaranteed an epidemic of foreclosures. Given the Fed's secrecy, neither farmers nor other debtors were given fair warning of what the government was doing to their financial condition. Indeed, long after the Fed had begun its campaign, various federal agencies were still making and guaranteeing small business and farm loans that were literally doomed to fail by the Fed's monetary policy. The central bank didn't give farmers a clear warning, and it didn't tell the Department of Agriculture or the Small Business Administration, either.
This is not to blame the Fed for every bad thing that happens, and certainly not to argue that Reaganomics was right while the monetary policy was wrong. My point is that Federal Reserve policy makers faced excruciating trade-offs and usually had to choose between two bad outcomes. Yet these stark trade-offs were not generally known or understood, much less openly debated by the elected representatives. This great collision between monetary policy and fiscal policy unfolded in broad daylight, but only the most sophisticated citizens even understood that it was happening.
Another example, closer in time: In the presidential campaign of 1988, both candidates naturally promised voters that they would deliver expanding economic growth and abundant jobs. Meanwhile, Fed Chairman Alan Greenspan and the FOMC were pursuing the opposite objective: slowing down the economy, suppressing consumption, and thus increasing unemployment. Right in the middle of the campaign, the Fed started ratcheting up interest rates and continued to do so for the next year or so. When short term rates were pushed higher than long term rates, the Fed was flirting with recession. I don't know if that is what the Fed intended--maybe not--but that is what the country got.
Question: Did Congress know the Fed's tightening monetary policy was pushing the economy into a full-blown contraction? Evidently not. Just as the recession was taking hold, Congress adopted the famous deficit reduction deal of 1990--raising taxes in the face of recession and thereby deepening the pain and destruction.
By the way, this is not a judgment made in hindsight. I wrote as much at the time in the pages of Rolling Stone: First that the Federal Reserve was inducing a recession and later that the 1990 budget deal would thus make things worse--including making the federal deficit worse. My analysis was based on what financial sources in Wall Street told me was happening and on a very straightforward observation: Every recession since World War 11 has been preceded by similar behavior from the Fed. When the central bank pushes short term rates above long term rates and holds them there--the so-called inverted yield curve--a recession follows.
Question: Would Congress have changed its budget decisions in 1990 if members had understood what the Fed was doing? At the time, Greenspan was urging passage of the budget accord and assuring everyone that recession was not at hand. As I said, the Fed is not infallible, either.
Reforming the Fed should have two goals. First, it must foster a more coherent and rational coordination between monetary and fiscal policy. And second, the cloistered debate must be opened up so that many more voices can be heard. The first step toward reform requires public education, not changing the institution. Over time, if elected political leaders develop a better grasp of the subject, they might be willing to examine the deeper power relations and consider changing them.
The Federal Reserve will naturally oppose both public education and institutional reform. As a political institution, it has skillfully mobilized its constituencies over the last 80 years to oppose any intrusion on its mystique. Right at this moment, bankers are busy heckling members of Congress, warning them about the dire implications of Fed reform. Guess who asked the bankers to do that.
In 1913, the Federal Reserve seemed like the grand compromise, and both political parties supported it. Both parties have stood by it since. In 1993, we are on new ground. The Fed is more influential than it pretends but also less powerful in the global economy than it once was. If this country is ever going to come to grips with the new global economic realities threatening our long term prosperity, we need to hear a lot of honest arguments about how the government manages the economy. That is impossible so long as half the story remains fogged from view.
Wiliam Greider is national affairs columnist for Rolling Stone and the author of Secrets of the Temple (1987) and Who Will Tell the People? (1992). This article is adapted from testimony he delivered before the House Banking, Finance, and Urban Affairs Committee.
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|Title Annotation:||Federal Reserve System's secretive practices|
|Article Type:||Cover Story|
|Date:||Dec 1, 1993|
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