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No Such Thing as a Neutral Fed

Summary:
If one follows news relating to the economy, they surely have come across certain mainstream rhetoric in support of the Federal Reserve System. Everyone is familiar with the typical claims that the Federal Reserve strives for maximized employment and low inflation, and that the Fed is the regulator of the banking industry. But king of them all is of the supposed political neutrality of the Federal Reserve.The Federal Reserve itself touts its elevation above the petty conflicts and interests of the three branches of government. The Fed’s website declares,Congress has determined the Federal Reserve can best achieve its mission of supporting maximum employment and stable prices as an independent agency that makes decisions based on the best available evidence and

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If one follows news relating to the economy, they surely have come across certain mainstream rhetoric in support of the Federal Reserve System. Everyone is familiar with the typical claims that the Federal Reserve strives for maximized employment and low inflation, and that the Fed is the regulator of the banking industry. But king of them all is of the supposed political neutrality of the Federal Reserve.

The Federal Reserve itself touts its elevation above the petty conflicts and interests of the three branches of government. The Fed’s website declares,

Congress has determined the Federal Reserve can best achieve its mission of supporting maximum employment and stable prices as an independent agency that makes decisions based on the best available evidence and analysis, without taking politics into consideration.

Experience around the world has also shown that countries with independent central banks that are able to make decisions free from political influence have better economic outcomes for their citizens.

If one is to take the central bank at face value, it is the one true neutral body that overreaches the lives of the citizenry. It claims that its only goals and motives are that prescribed by Congress through the Federal Reserve Act and various other legislation that guide the central bank. Congress and the executive branch are explicitly political in nature, and the Supreme Court is hardly the “unbiased arbiter” that it passes itself to be. The Federal Reserve is no outlier in this respect.

It is easy to take this truth—that the Fed is a political monetary regulator—for granted, but it is helpful to understand why. To be able to articulate the reasoning clarifies it.

The Federal Reserve is levied with a dual mandate to ensure low and steady inflation and maximum employment. Surely these come across as objective metrics and goals that supersede political squabbles, yet their very prescription is political. One is led to ask, why is the central bank responsible for employment? How much inflation is low and steady? Why that much? These are arbitrary edicts, derived from congressional acts and legislation. Even the 2 percent target for inflation is a relatively new proposal, coming from our current Treasury Secretary Janet Yellen.

These mandates are up to the legislature, as the central bank reports to Congress. These mandates might be as arbitrary as Congress decides. The central bank must conform to political interests, or the interests of the polity will be enacted into it.

The Fed also falls victim to appointment corruption. The Chair of the Federal Reserve is appointed by the president of the United States, as are the two vice-chairs that serve similar four-year terms. While the other governors on the Federal Reserve Board in Washington are appointed to fourteen-year terms, they are appointed nonetheless. Appointees earn their position by conforming to the interests of the executive. Much like liberal presidents will appoint liberal Supreme Court Justices, a presidential administration will appoint members to the board that conform to the interests of the administration.

Long length of terms might serve as a necessary check, as governors aren’t beholden to specific presidents. Staggering terms over presidential terms, which prevents loyalty to one administration, might also provide a necessary check. These solutions seem nice at face value, but careful public choice analysis disproves these misconceptions.

These long terms being limited to just one simply means there is a limited window for the governors to make use of their positions. Surely, they could work for the best interests of those affected by monetary policy, but it is far more likely that these governors will make use of this limited time to benefit themselves. While not the governors themselves, the presidents of the Dallas and Boston Feds acted in such a manner with insider trading. The governors have an incentive to benefit themselves as much as possible, including with their stances on monetary policy.

The chair and vice-chairs are even more susceptible to political pressures. With reappointment on the line, the Fed chair is beholden to whoever nominates them next. It is a careful game of either assisting the incumbent if they believe the incumbent will be reelected or getting in the good graces of the new incumbent. They will fold to pressure and adjust policy in any manner that will gift them reappointment.

Donald Trump was ever a fan of placing pressure on the Federal Reserve. Trump ran on a platform of auditing the Federal Reserve amid his criticisms of the political elite. Yet, once he entered office, he pivoted to pressuring the Federal Reserve and his appointee Jerome Powell to cut interest rates, which the Fed did happily.

When lockdowns occurred, Trump advocated for further rate cuts amid lockdowns. However, Trump lost the 2020 election, and Joe Biden entered office and became the next man to appoint the next Federal Reserve chair. Amid soaring inflation and his reappointment, Jerome Powell dubbed inflation “transitory” and held back on raising interest rates to combat inflation. Interest rate hikes very well could have brought about a recession, albeit necessary. Causing a recession is hardly a means to be nominated as chair once more. Once Powell was renominated and confirmed for his second term, rates were allowed to rise to historic levels.

The central bank’s policy actions are heavily dependent on political pressure and the interests of the executive, legislature, and those that govern it. The Federal Reserve’s policy actions are not only arbitrary but also often politically motivated. It does not exist as some benevolent government agency that is above political motivations. It is simply another road into the lives of average citizens for political dictation of the economy and life.


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