An expert panel at Cato’s 30th Annual Monetary Policy Conference considered the issues of the limits of monetary policy, which has been conducted in a very aggressive and expansive manner by the Federal Reserve since the 2008 financial crisis.
The highlight of the panel was the delivery of a paper by Allan Meltzer, a professor of economics at Carnegie-Mellon University titled “What’s Wrong With the Fed: What Would Restore Independence?” In Meltzer’s absence, the paper was delivered by the moderator of the panel, Bill Poole, a resident scholar at Cato and formerly the conservative CEO of the Federal Reserve Bank of St. Louis, who inserted some of his own comments into the reading.
The Meltzer paper began with a quote from Alan Sproul, president of the Federal Reserve Bank of New York from 1941 to 1956, “I don’t suppose that anyone would still argue that the control of the banking system should be independent of the government of the country. The control which such a system exercises over the volume and the value of money is a right of government and is exercised on behalf of government, with powers delegated by the government. But there’s a distinction between independence from government and independence from political influence in a narrower sense. The powers of the central banking system should not be the pawn of any group or faction or party, or even of any particular administration, subject to political pressures and its own passing political necessities.”
Meltzer than addressed the question of how such a standard of independence could become a reality. Federal Reserve dogma holds that the Fed is “independent within government.” He found that this was the case from the founding of the Fed in 1913 through 1917, but at that point, the Fed got involved in the financing of the debt from World War I, then the Treasury Secretary insisted on maintaining low rates, “and so on,” according to Meltzer. “It has been ever since.”
Gerald O’Driscoll, senior fellow at Cato, addressed the historic Accord of 1951, which has often been cited as the defining moment that established the Fed’s independence from any obligation to support the Treasury’s financing of the government’s debt. However, what is often forgotten, O’Driscoll pointed out, is that Fed Chairman Thomas McCabe was immediately fired by President Harry Truman in 1951 even though his term was scheduled to run to 1956.
Former Fed Governor Kevin Warsh, in a rambling presentation, called on the Fed to consider the situation in which monetary policy is being applied and whether proposed actions are actually within the Fed’s remit, because exceeding this authority risks undermining the credibility that itself burnishes the Fed’s ability to act available. Warsh asserted that this credibility is more valuable than all the other assets on its $3.5 trillion balance sheet.
In the final paper, David Malpass, a former Treasury official and current president of Encima Capital, examined current Fed policy, its economic impact and possible exits. He criticized the Fed’s policy as “contradictory,” because it is “hurting savers, damaging markets and channeling capital away from job-creating parts of the economy.” Second, he faulted the Fed’s most recent actions as “a major increase in the aggressiveness of monetary policy and the contractionary impact of that policy.”
Malpass’ proposed exit is a package of “pro-growth” tax, spending and regulatory policies in parallel with a growth-oriented Fed resolve to provide sound money and downsize its role in capital allocation. He proclaimed that, “The combination would encourage investment and hiring in the U.S. private sector.”
This short article cannot do justice to the extensive presentations made by the panelists, but even those presentations missed some critical questions.
One of these is whether, even if officials of the Fed and Treasury could be convinced that a rules-based policy would produce a more satisfactory macroeconomic result, these officials could resist the temptation to burnish their own value by doing chores for politicians and future private clients.
Furthermore, in rightly crediting former Fed Chairman Paul Volcker with raising interest rates enough to halt the momentum of the post-Great Society inflation, leading into a severe but short-lived recession, the panelists neglected to address the intricacies of the relationship between Volcker and the Reagan administration.
In my view, administration officials were only too glad to blame the recession on the Democratic Fed chairman, and they waited until nearly the end of Reagan’s presidency to install a Republican in the post — Alan Greenspan.
Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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