The Fed’s policymaking Open-Market Committee met this week and lowered the range for its target interest rate by one-fourth of a percent. Two committee members, both presidents of Fed District Banks, dissented. In a press conference after the meeting, Chair Jerome Powell expressed uncertainty about several issues but made clear that this cut did not start a planned series. Any future actions would depend on how conditions unfold.
President Donald Trump, who had demanded a half-point cut, reacted harshly, although his criticisms of the Fed and of his own appointee as chair are now so common that they raise little notice. The stock market dropped a couple of percent.
There are two takeaways from all this. First, Marriner Eccles, the Utah businessman and banker who was the architect of the modern Federal Reserve, was a genius. Second, hardly any U.S. journalist, even those supposedly covering monetary policy, really understands how the Fed works.
The background is that our economy is doing very well by conventional measures. The unemployment rate is low. The number of people with jobs has risen. Measured consumer inflation is low. Borrowing costs for businesses and consumers are low, although the flip side is that savers have been pummeled for a decade. The stock market is at historic highs and housing prices have recovered all their drop after 2008. The current expansion is nearly the longest on record.
Yet clouds are on the horizon. We have an unprecedented high and rising federal fiscal deficit when the economy is hot. The Trump trade war and the president’s mercurial approach to many policy issues engender economic uncertainty. Rising tensions in the Persian Gulf threaten higher energy prices. And the stock market, in the classic final phases of a bubble expansion, is volatile.
Moreover, we already are in a presidential campaign season. Sitting presidents running for reelection always want monetary expansion from the Fed. Trump is not an exception. But, as for many other areas, the extremity and volatility of his rhetoric about the Fed’s leadership and policies is unprecedented in U.S. history and puts the central bank in an institutional crisis.
Its design in 1913 and restructuring in 1935 centered around keeping the Fed insulated from political pressures. Seventeen U.S. presidents, from Wilson through Obama, have largely respected that operating autonomy, at least in their public pronouncements. But Trump has thrown prudence and discretion in dealing with the Fed to the winds.
So the Fed is in a hard place. It must meet its statutory mandate of maintaining stable prices consistent with maximum employment. But it must also defend its own autonomy against pressure from Trump.
This is not a minor issue. The most important aspect of any central bank is its credibility. This is hard to win and easy to lose. And the reputation of the U.S. central bank determines the reputation of the U.S. dollar as an international reserve currency and of U.S. capital markets as the safest refuge in any global economic storms. Allow a U.S. president to dictate U.S. monetary policy and that all erodes if not immediately collapses.
Legally, Powell and his colleagues should feel no pressure. There is nothing in the Federal Reserve Act that allows a president to fire any member of the Board of Governors over policy differences. Some 85 years of precedent and tradition oppose it. But Donald Trump does lots of things for which he has little constitutional or statutory authority. The separation of powers that underpins our democracy only functions as long as each branch is willing to check and balance as needed.
As long as the GOP majority in the Senate is complaisant with any Trump action, Federal Reserve officials can fear that Trump might provoke a financial and constitutional crisis by attempting to fire Powell or other governors. Administration policies are already the major source of uncertainty in a fragile global economy. An overt attack on Fed autonomy would raise that exponentially.
It is reassuring that Eccles provided for such an eventuality.
The structure of our central bank has always been rooted in a rift going back to Thomas Jefferson and Alexander Hamilton. One side is the Jeffersonian public fear of the power of concentrated money. The other is a quasi-Hamiltonian fear of the power of concentrated government. That split caused the establishment of a decentralized central bank with 12 autonomous branches in 1913.
It also underlaid Eccles' 1935 design of monetary policy controlled by a committee made up of governors appointed by presidents and confirmed by the Senate, balanced by presidents of the 12 district banks. These banks legally are individually chartered private corporations. Their presidents are chosen by their respective boards of directors. The president and Congress have no power whatsoever over these presidents without deep revisions in the Federal Reserve Act.
Yes, there are seven governors and only five presidents voting in any single meeting. But global confidence in the Fed’s autonomy is such that no chair can move any monetary policy action that would provoke more than two, or in an extreme case, three dissents on any vote. The chair’s motion always carries, but only because a wise chair knows not to make a motion that will fail or even be challenged.
Thus, the district bank members of the FOMC can flip the president of the United States the bird. That is just what two of them did at the July-end meeting. The press focused on apparent wavering by Powell at the press conference and ignored the role of the two dissents.
Powell’s personal position probably was for only a quarter-point drop. But it is also likely that if he had moved a half-point drop, he would have faced three dissents or even more. That would have made Wednesday’s roiling of financial markets look like a sneeze.
Reporters do not understand the subtle diffusion of decision-making power within the Federal Reserve. Conventional practice is to treat the chair as a monarch with the other six governors as Guardians of the Monetary Chamber Pot and the 12 district presidents as mere spear carriers in the royal retinue. This reflects ignorance and it confuses not only the general public, but financial markets. It certainly did after this meeting.
For a more salient example, return to the first foreshock of the great financial debacle. Around Aug.10, 2007, commercial paper markets started to seize up, especially in Europe. These are markets in which very-short-term, unsecured corporate IOUs are bought and sold. Suddenly, there were no buyers to meet normal offerings.
The European Central Bank pumped in some 45 billion euros in one day to restore normal market liquidity. The U.S. Fed put in nearly as much over two days. This size intervention was unprecedented in human history.
The FOMC had an emergency teleconference meeting on Aug. 10, 2007, decided no interest rate change was needed and issued a bland statement merely noting it had discussed the situation.
On Aug. 17, it conferred again. Once more it did nothing and issued the required statement. This listed all the committee members, starting with Chair Ben Bernanke. Apparently, all agreed that nothing need be done.
But then on the same day the Board of Governors, which is the FOMC minus the district presidents, issued a statement that it had met and had decided to approve a lowering of the discount rate. This is the rate at which the Fed loans directly to banks. It is largely symbolic. But it is a rate in which the Board has a say, even if most district bank presidents are opposed.
Even here, it does not have control. It can only approve requests for changes that come from “one or more” district banks. Two banks had requested a lowering. Ten did not think it wise. But the Governors could lower this rate for the whole nation based on such tenuous grounding.
The important fact here was that the Fed was internally split. Bernanke could not get support from a 12-member committee for the reduction in an important interest rate. So he fell back on support in a seven-person board for a change in a largely irrelevant one. Perhaps he intended to send a message to global markets that the Board was aware and watching. But it also sent a message that the power of the Fed Chair is highly limited. The media were oblivious to this.
Two Fed presidents threw an important marker down in front of the president this week. Even if he succeeds in hectoring the Board into doing his will, the district presidents have veto power. Trump’s economic advisers will understand this if he doesn’t.