(Bloomberg View) -- A widely held view of the modern Federal Reserve holds that the Fed independently crafts U.S. monetary policy, free from short-term political interference.
But if you look at the political and economic catalysts that fueled the Fed’s development over its first century, and concentrate on Congress’s relationship with the central bank, it’s clear that this independence is a myth. At best, the Federal Reserve earns partial and contingent independence from Congress -- and thus barely any independence at all.
Instead, Congress and the Fed are interdependent.
Congress relies on the Fed to both steer the economy and absorb the blame when it falters. On balance, when the economy is sound, lawmakers propose fewer changes to the Federal Reserve Act, and Fed autonomy grows as legislative interest in monetary policy subsides. So long as the central bank delivers economic growth and inflation rates that are consistent with its mandate, few lawmakers will focus on the Fed’s conduct of monetary policy. Congressional indifference seems like Fed independence.
But when macroeconomic outcomes are poor, lawmakers shift responsibility to the central bank, insulating themselves electorally and potentially diluting public anger directed at Congress, and they renew calls for reform.
Tallying up consequential changes to the Federal Reserve Act over the Fed’s first century, we find 18 major episodes of reform: Some clip the Fed’s autonomy, others empower the Fed, some do both. Controlling for the duration of recessions, Congress is more likely to amend the act when the nation experiences higher rates of inflation or unemployment.
Action is also more likely when one party is in control of both the White House and Congress, since in that case voters know whom to reward or blame. When parties divide power, voters have a harder time apportioning blame. The pressure to act peaks when electoral rewards are greatest.
We used legislative records to explore lawmakers’ attention to the Fed, examining bills introduced in the House and Senate between 1947 and 2014 that address the power, structure and governance of the central bank. Over nearly seven decades, 333 House and Senate members introduced 879 bills. Legislative proposals rarely become law, but they do signal lawmakers’ monetary and regulatory priorities.
In the chart, we plot the number of bills introduced each year, alongside a smoothed “misery index” (the sum of annual inflation and unemployment rates).
The most recent spike in legislative attention to the Fed came in the wake of the global financial crisis, which began in 2007. In contrast, congressional interest dropped precipitously during the so-called Great Moderation of the 1980s, when the Fed, led by Alan Greenspan, tended to hit its targets.
During economic downturns, congressional sentiment leans toward limiting the Fed’s policy-making discretion, as noted, though some lawmakers propose bills that give it more power. Legislators are also more likely to threaten greater oversight of the Fed -- such as expanded government audits -- when the economy slips.
Democratic lawmakers are more prone to attack the Fed when unemployment is high. In contrast, Republicans have often advocated a single, inflation-fighting objective, especially after 1977, when a Democratic Congress cemented the Fed’s dual price-stability and labor-market mandate.
The Fed has been caught in the crosshairs of contemporary partisan polarization. On some issues -- especially related to the transparency of making monetary policy -- we even find odd congressional coalitions. Lawmakers from the ideological fringes of both political parties often make common cause in advocating reforms such as requiring greater disclosure of who gets emergency loans from the Fed.
The Fed’s dependence on Congress is more intuitive, if under-appreciated. By repeatedly revising the Federal Reserve Act -- or threatening to do so -- Congress signals to central bankers the costs of failing to meet lawmakers’ expectations. Fed power -- and its capacity and credibility to carry out unpopular but necessary policies -- is contingent on securing and maintaining broad political and public support.
Failure to sufficiently engage lawmakers raises the risk that Congress and the president could retaliate by circumscribing future Fed autonomy or undermining monetary policy with too little or too much fiscal policy.
Today, the Fed bears only passing resemblance to the institution created by Democrats, Progressives and Populists more than 100 years ago.
After the devastating banking Panic of 1907, a Democratic Congress and President Woodrow Wilson enacted the Federal Reserve Act of 1913, creating a decentralized system of currency and credit, and sidestepping Americans’ long-standing distrust of a central bank. After the Fed failed to prevent, and arguably caused, the Great Depression of the 1930s, lawmakers rewrote the act, taking steps to centralize control of monetary policy in Washington, while granting the Fed some independence within the government.
More than seven decades later, the 2007-2008 global financial crisis retested the Fed’s ability to overcome policy mistakes and prevent financial collapse. Congress responded by significantly revamping the Fed’s authority, bolstering its financial regulatory responsibilities, while requiring more transparency and limiting the Fed’s exigent role as the lender of last resort. In this way, legislators could both shift more blame to the Fed for the cascading problems and protect themselves from voters’ wrath, as well as appear to be doing something to rein in the Fed.
In such periods, the Fed is insufficiently insulated within the political system to make tough policy choices without gauging potential reactions from a blame-avoiding Congress and an angry public.
To be sure, the staggered terms for the Fed chair, its budgetary autonomy and private-sector involvement in the reserve system backed with other statutory features buffer it. But the Fed is not immune to public, presidential or congressional attacks, even if they result in no action.
The criticism directly harms the Fed’s credibility, the most important asset for an organization seeking to maintain its power and autonomy, and complicates the Fed’s ability to convince markets, businesses and the public that its often complex, sometimes temporizing policies are consistent with Congress’s directive. Years after the global financial crisis, a robust recovery remains elusive, and public trust of the Fed remains fragile.
The enactment of a multiyear transportation bill late in 2015 illustrates the Fed’s dilemma. After several years of stalemate over raising the gas tax to finance federal highway spending, Congress and the Obama administration agreed to a proposal that would raid the Federal Reserve’s capital surplus instead of raising the gas tax. If the Fed’s public standing had been stronger, we doubt it would have been such easy prey for the lawmakers’ fiscal sleight of hand.
Despite an improving economy, the 2016 elections revealed the deep political reverberations of past economic shortfalls and monetary-policy failures. Congress will continue to direct the Fed to pursue long-term economic outcomes consistent with the public’s evolving priorities, and then threaten action if the Fed fails to deliver. So long as lawmakers remain risk-averse re-election seekers, blame-game dynamics will shape the Federal Reserve.
(This article is adapted from “The Myth of Independence: How Congress Governs the Federal Reserve,” published this month by Princeton University Press.)
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mark Spindel is the founder and chief investment officer at Potomac River Capital LLC. He is co-author of "The Myth of Independence: How Congress Governs the Federal Reserve."
Sarah Binder is a professor of political science at George Washington University. She is co-author of "The Myth of Independence: How Congress Governs the Federal Reserve."
To contact the editor responsible for this story: Katy Roberts at kroberts29@bloomberg.net.
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