Jan 15, 2018

Sarah Binder and Mark Spindel on Fed History and the Myth of Its Independence

The Federal Reserve has developed a resounding political independence since its founding, but recent economic events have raised new questions about the central bank’s unilateral power.
David Beckworth Senior Research Fellow , Sarah Binder, Mark Spindel

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Sarah Binder is a professor of Political Science at George Washington University and a Senior Fellow at the Brookings Institution. Her research focuses on Congress, Congressional development, and political parties. Mark is the founder and chief investment officer at Potomac River Capital LLC, and formerly was with the World Bank. They join Macro Musings to discuss the history and politics behind the creation of the Fed as well as their new book, *The Myth of Independence: How Congress Governs the Federal Reserve.*

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Sarah and Mark, welcome to the show.

Sarah Binder: Great, thanks for having us.

Mark Spindel: Nice to be, thank you.

Beckworth: Well, it's a great book. I read through it. I learned a lot and it sharpened some of my thinking on these issues of Fed independence or the myth of it as you've put in the title. I'm curious, though, how did you guys get down to this project? What led you into the path of looking at the history of the Fed and its relation to Congress?

*The Myth of Independence*: Motivation and Summary

Spindel: Why did we write the book? I think a surface level explanation would absolutely focus on the financial crisis. This was a 10-year project, and Sarah and I simply wanted to understand the ways in which Congress shaped the near and medium term outlook for markets, the economy and monetary policy. As an investment manager, focused on the impact of politics and policy, really a sort of existential and elemental force in markets. Keep in mind, I ran a hedge fund, and at 2:07 PM on September 29th, 2008, I was totally lost. Markets and the economy were in disarray, Fed Chairman, Bernanke and his colleagues had lobbied quite hard for the just torpedoed TARP legislation. So for sure, Congress was in disarray, and whenever I have questions and confused by the legislature, I called Sarah and indeed I did. And that really sort of formed the first basis of the conversation and the book.

Beckworth: Now, Sarah, were you researching the Fed already or was that the motivation?

Binder: So not really. I mean, I've been studying Congress for 20 plus years, and the financial crisis is unfolding, and so the question arises of what's different here? And it turns out, at least initially, nothing really was different. That members of Congress are electorally minded, and it happened to influence how they reacted to the crisis, which was no one really wanted to vote for TARP. And so the more we got into it, we found some interesting questions about the Fed and coming to the hill and the discussions and the Fed's involvement in trying to shape what TARP, the bailout was going to look like. That got us into all sorts of questions about what is this really weird, oddly structured institution that's so important, and yet political scientists have really not spent a lot of time thinking about?

Binder: We've really let the historians and the economic historians write the book. Then we thought maybe let's bring some politics into, does it help change the way we think about the Fed, its job, why we have it, why it looks the way it does, and what difference does it make?

Spindel: And I think prior to the crisis, I'd spent a lot of time thinking about central banking, and a senior staffer at the Fed had reminded me that it is a Federal Reserve, and in that name alone, is a sort of part of this weird, strange structure. As you look at the history, which of course you have, you sort of understand the decentralized nature of this central bank. And I think the more we started to sort of peel back the issues in the crisis and the century of history that the Fed had, we just began to really get a sort of good sense that it had been unstudied.

Spindel: The economic historians, as Sarah said, had done a lot of macro work, but the politics really just begged for more analysis. And I think when we first put the book together, The Myth of Independence was not the title we had chosen. All through-

Beckworth: It's a catchy title though. It's great. Great marketing.

Spindel: ... Absolutely.

Binder: As we were told.

Spindel: It's a much more provocative title and provocative explanation of what we were doing. But the title that we worked with throughout the project was monetary politics, which I think gets at, what for Sarah and me is really a rare collaboration. You have an academic and a practitioner. And I think that combination, one of us steeped in careful analytical methods, renowned political scientists, an expert on Congress, and congressional procedure, the other basically a bond trader. And I think that helped to generate a perspective that really goes into how the Fed's relationship with Congress matters, how it matters for the politics, how it matters for the economy and how it matters for markets.

Beckworth: Well, it's a great book, and we'll have a link to it on our website. But give us the executive summary, the 30,000 foot view of the book. What is the argument of the book, and what did you find?

Binder: So there's a very well developed body of economic work on central bank independence, right?

Beckworth: Mm-hmm (affirmative).

Binder: And the prevailing story is that politicians, they know, they want to juice the economy for their own electoral purposes, but they know that with juice the economy is future inflation. And so the theory goes from economists that members of Congress basically tie their hands behind their back, right? They create an independent central Fed, they delegate authority over monetary policy, it's better, they're experts, and now, Congress ties their hands, and now they can't interfere. And so the economy will be better because of that.

Binder: That story makes no sense to a political scientist, right? For those of us who study Congress, David Mayhew, 1974, said members of Congress are single minded seekers of re-election. And so you have to ask, well, why would you ever tie your hands behind your back if it's the cost is you can't juice the economy, right? That's what they're there for. So once you start looking into the Fed, what do we find? We argue that this notion of independence, it's mostly myth, and so we propose instead to think of Congress and the Fed as interdependent institutions.

Binder: So what's the overview here? First, think about, from the Feds perspective, right? Congress is the boss, right? He has Ben Bernanke at his last press conference, do you have any advice for the incoming Fed chair when dealing with Congress? And Bernanke said, "Yes, Congress is the boss." Right? They're very clear. Why? Because Congress, we know has the authority to reopen the Federal Reserve Act, rewrite it in ways that the Fed might not like, give it more responsibility, clip its wings, impose more transparency.

Binder: So the Fed has to be aware what the boss wants and what the boss doesn't want them to do. And from the other perspective, right? Congress is looking and they depend on the Fed too, right? First, probably don't want, five and 35 members writing a monetary policy, just a hunch. But importantly, Congress also needs someone to blame when the economy goes south. And so that's conscious dependence on the Fed. They really do need each other, and so we argue, once you look at that interdependency, it gives rise to a cycle. We call it, crisis, blame, reform, right?

Binder: The Fed is empowered to manage the economy, sometimes it’s owned by its own fault, sometimes other forces, the economy goes into a downturn, economic crisis, or financial crisis. And Congress looks for someone to blame. They blame the Fed, they reopen the act, and then sometimes, ironically, they give the Fed more power, right? So in the wake of Dodd-Frank, financial crisis, Congress turns around, they give the Fed more power, right? They make it the Uber regulator of big, systematically important institutions.

Binder: And we've traced that cycle over time to show that over 100 years, it helps explain why and how the Fed has turned into this remarkably powerful institution, but also remarkably transparent because the boss has said, wait, we want to know what you're doing. And the more power they give the Fed, the more power they centralize in Washington and the board, the easier it is to blame the Fed when things go wrong. And so that's really the argument in a nutshell, right? That rather than thinking of the Fed as an independent institution, think of these as interdependent institutions, and I think it helps us to explain this ongoing relationship between the Fed that they really do both need each other but for different purposes.

Beckworth: We'll get into the details later. But this explains the ratcheting up of the Fed's power, the decentralization of the Fed's power because it was originally created as you know in the book, very decentralized organization. The regional banks set their own monetary policy, which is, from my perspective, very fascinating, and 12 different monetary policies in the US going on, very interesting. But let me ask a question about this theory. So this mechanism you have your theory is that Congress gives more power to the Fed is a way to cast blame on them when things go bad, right? And it seems to fit well with history as you outline in the book. But one thing I couldn't think of this is almost too smart for Congress. I mean, is it as an accidental? They find themselves in a bind, oh, let's give them, we can blame them or is well thought out in advance?

The Fed as a Congressional Scapegoat

Binder: So certainly, this electoral incentive is always there for members and members, they're very good at finding people to blame. I mean, that's part of the DNA, and even more so, they're very good at manufacturing blame, right? Not just finding someone to blame but generating blame, right?

Binder: Itself, and certainly, if you ask them, about 1960s or so, McChesney Martin, who was the longtime Chair of the Fed, was testifying before, must have been the House at the time, House Banking Committee, and he said something interesting. He said, look, we're here to be blamed.

Beckworth: Oh, wow.

Binder: That's what we're here for, and we know it, members know it…

Spindel: It was a celebration of the Fed's half century. It was really a testimonial, and sort of talked about bearing the slings and arrows of members of Congress, of the boss.

Beckworth: Wow. So they wear a shirt with a target on it saying, take your shots.

Binder: Yeah, and I think the myth is helpful to central bankers to say, look, we're here to do the hard work here. But I think they understand that blame is really part of the game. I mean, lawmakers know that if they do nothing, the Fed's going to step up, because it's part of their mandate, and they're judged on how well they perform in managing the economy. Otherwise, Congress will reopen the act again. And so they know. Something about the crisis after the initial stimulus in 2009. And then there's this you have Bernanke and others on the FOMC saying, where's all these fiscal headwinds? Right? They're cutting. There's more austerity than expansion.

Spindel: No panacea from monetary policy desperate for a sort of continuing fiscal boost.

Binder: Right? But lawmakers, I don't know if all them understand this, but they certainly know that the Fed's going to step up, and the feds going to step up and they're still going to blame on whether or not Congress is part of the cause of why their job is so difficult.

Beckworth: So it's in their DNA, it's almost instinctual.

Spindel: Yeah. I mean, I think there's a number of ways to look at the economic performance lately. But in terms of the headline numbers, the numbers that are part of the actual law, the dual mandate, unemployment is at 4.1%, Inflation modestly below target but rising gently, orchestration of a interest rate hike of a balance sheet unwinding. Chair Yellen has done a remarkable job, and it's not to suggest there aren't underlying structural issues. But for the last few years, I think there's been a merciless attack from both the left and the right, on the Fed from Congress. And as Sarah said, even when there might not be reasons to blame them, it serves their political convenience to do it.

Beckworth: It's convenient. Well, I think that the Humphrey-Hawkins hearings, I mean, especially on the congressional side, the House of Representatives side, it's a lot of theatrics. I mean, a lot of, I won't say yelling, but a lot of finger pointing. They talk past each other, I get the sense. And I've even seen it on the Senate side. When I was still an academic, I was once invited to one of my senators offices up here, I flew up and I met with them and I gave him my spiel, this is right after the crisis, and I explained that, really, the Fed wasn't being that crazy.

Beckworth: It was doing things they had to do and maybe in my view because I mean more, and I thought I explained that very well to the staffers and then I see this particular senator go on the floor and just rip Bernanke apart, and I was like, that is not what I told the staffers. And later I was told, look, he's just throwing a bone out to his constituents. It makes him look good back home. He gets to the local news, I don't think he was up for reelection, but just kind of a, it's good theatrical.

Binder: And I think it is theatrics. So we don't really know what members if they have pure preferences about monetary policy, they probably don't. But the theatrics matter, because they spill over, and we try to show the ways and that they spillover to have what the public to the extent they think about the Fed. It's below [inaudible] to what they think about the leadership of the Fed, about the state of the economy. So yeah, it seems like theatrics and certainly that's the name of the game for most congressional hearings.

Binder:  But it spills over to how people perceive what the Fed is doing. And of course, the Fed needs to be believed that they're going to do what they say they're going to do. And so these criticisms that come from either the left or the right, I think it certainly makes their job harder, right? The moment if you think that they could not do what they said they're going to do, right? That's problematic, certainly in the world of monetary policy.

Spindel: Well, I think they do have, in some cases, some strong ideological views about monetary policy, and that has run through the history of the institution. I think the natural differences between creditors and debtors, inflation, which, I think, ironically, has not really been a major problem for the Fed over the last 100 years. There was obviously the sort of huge 70s show which sort of led to sort of revisiting the act. But principally, the problem that the Fed has had to face is a deflationary or disinflationary one, a sort of low inflation.

Spindel: So I think that ideological difference between, let's say, conservatives and progressives or Democrats and Republicans, that definitely comes out. And I think, we've listened to what members have said, but part of the sort of learning certainly from Sarah has been, what are they voting on? What is the actual sort of nature of the legislation? How are those votes cast? And, sort of in going through this legislative initiatives, this was not our first central bank, right? We had two banks of the United States that existed prior to the Fed, and I think some of the stickiness in the Federal Reserve and in the Federal Reserve Act is that it's changed a lot over the last 100 years. It started as we said, as a very decentralized institution and has become not just a major central bank in the US, but really the sort of global force for monetary policy.

Beckworth: Oh, absolutely. I've written some papers on how consequential that is to global monetary conditions, not just US. And I think that's a underappreciated point that you raised there. Well, let's move on in your book, because you have a fascinating chapter two where you actually present some empirical evidence. You guys have compiled some interesting public opinion polls, data over the 40 years. I was really impressed with this data set you created. You look at 879 bills between 1947 and 2014, created a nice time series. So what were some of the highlights from chapter two you want to share with the listeners?

Explaining the Empirical Evidence and Its Implications for Today

Binder: Sure. Figure 2.4. Let's go to the figure. So we take all those bills, we search, we pull them out, any bill in which a member of the House or Senate has introduced since the 40s that has something to do bearing with the Fed, it could be monetary policy, it could be regulatory... What do we show there? And we carve it up lots of different ways but the story is always the same, which is that lawmakers attention to the Fed is counter cyclical, right? When the economy is doing well, say the great moderation, late 80s into the early 90s, very little legislative activity, no threats coming from the Hill. But when the economy turns down, especially when unemployment goes up, lawmakers are they're introducing bills.

Binder:  Sometimes they do give the Fed more power, but by and large in these economic downturns, these bills constrain the Fed. They impose more requirements, they clip their wings. So there's the sense that if we were right about the cycle, right? Crisis, blame, reform, that's the pattern we should see, right?

Beckworth: Right.

Binder: Lawmakers shouldn't have any incentive to go after the Fed when the economy's humming along, right?

Beckworth: Right.

Binder: But they should have an incentive when they economy is in a downturn. That's the sort of crisis and then the blame, and then the possibility of opening up the act. So we certainly see that. We have a couple other patterns in there. By and large democrats, the before the crisis and certainly before the 77 Act, where they really crystallized the dual mandate on unemployment and price stability. It's largely Democrats who ran on the game of attacking the Fed and challenging the Fed. And certainly in the wake of the crisis, Republicans really seemed to get that. And this is Mark's point about the ideological views, about here, about the proper role of monetary policy. They get in the game of sending those threats to the Hill, and we see it played out obviously in those hearings.

Binder:  So we see counter cyclical behavior there, but we also see counter cyclical behavior on when do they actually open up the act, right? When did they revise the Federal Reserve Act? Unemployment goes up, right? I'll throw all this stuff into a model. What's the likelihood that you open up the Federal Reserve Act? Unemployment goes up, the longer the recession, and unified party control, right? It's just the conditions under which, well, maybe not this particular period of unified party control, which they seem a little difficult to legislating, but by and large, we have these electoral episodes where there's some agreement, in the wake of crisis, open at the act, change the powers of the Fed.

Beckworth: Yeah, so I was going to ask, what are the implications for today? It seems to suggest that there's not going to be any radical change at this point going forward.

Spindel: Well, radical change from the legislative side seems a little less likely with this particular Congress and with the sort of diversity of views in the governing conference, the Republican side, but there's no doubt it's a great time to talk about Congress and the Fed, to the extent the protagonists in our story really do influence markets and the economy and are influenced by them. The appointment process, the really unique nature of Trump's ability to recast essentially entirety of the Board of Governors. The extent to which all of those Republican critics on Capitol Hill going after Obama appointees, we really do wonder how that criticism will change, or disappear when the GOP owns the Board of Governors to the extent there's been a sort of obvious rise in partisanship in all areas. The partisanship in attacking and blaming the central bank, I think may change a bit when they essentially own the institution.

Beckworth: I guess, when I look at where the Fed's going now with Jay Powell being appointed. This week, the name Mohamed El-Erian, was floated as a potential vice chair. It just seems so far from what I think many Republicans or their vision of, in fact, I talked to a former staffer for Jeb Hensarling, used to work for him, and he was very disappointed that Jay Powell, he was very distraught that Mohamed El-Erian, and immediately if I go back a step beyond that.

Beckworth: Now, of course, his view is I think, like a more of a hard money view. But I was thinking when Trump was first elected, and suddenly the market shot up, much to everyone's surprise, and then even expectations of inflation, I thought, man, what you guys traded, we call the reflation trade was here, and I thought this would be manifested not just in the markets, but in who he appointed at the... He would have a Fed that would accommodate his infrastructure spending plans, he would have a Fed that would tolerate a little bit higher inflation maybe.

Spindel: Why we wondered as early as January, why on earth he would want to appoint a hawk.

Beckworth: Exactly.

Spindel: And we wondered, as someone who was extremely sort of familiar with the liability and debt side of his own balance sheet and his real estate empire, that we thought he'd be much more tolerant. And I think, although it didn't come to pass, we had a much higher likelihood of the reappointment of Chair Yellen, both through a lot of the history that we went through in the book. I think there's some blame avoiding behavior in adopting or reappointing the chair from the previous opposite party.

Spindel: Again, I think the successful management, post crisis management of Yellen's and as the vice chair under Bernanke, all of that to us suggested that she deserved another appointment. I think when you looked at J. Powell's background, he is probably the closest Republican ideal to that kind of pragmatic, less hawkish or dovish behavior of Chair Yellen and the names that were floated which we can talk specifically or generally about them, they all seemed to us to just be more hawkish and why would he want that?

Binder: I think it's an important moment here, right? Given how partisan American politics has become, right? That it has spilled over even to this institution, the Fed, certainly Fed officials like to maintain a buffer. They'll tell you we don't talk politics around the table, right? A very big [inaudible] table where there is no partisanship here, but that institution can't escape it in Washington, right? And that appointment of pal to the extent that he's as close as they can get to Yellen so that he's more a dovish, and yet has an aura next to his name and to break the norm here of reappointing for a second term a sitting Fed chair who by metrics has done a good job.

Beckworth: Done a good, yeah.

Spindel: Completely aligned in monetary policy with Chair Yellen herself, never dissented.

Beckworth: So maybe he's a compromise between what the Republicans wanted and continuity?

Spindel: Right. It's hard to deny his Republican bonafides. I mean, worked for Bush, sort of came from the private equity side, has been sort of steeped in what we all agree would be a sort of area for focus, which is macroprudential and financial supervision and regulation, I think, soon to be confirmed chair Powell has a background there.

Beckworth: He's definitely, I mean, it's been interesting to watch. I guess my observation, it just seems a little deflated. I mean, relative to what the expectations were.

Spindel: Well, let me, I think Sarah and I are quite hopeful that he will continue the sort of successful navigation that Bernanke and Yellen have put in place. And I think an important aspect to J. Powell's tenure at the board has been an institutionalist, that I think some of the other names sort of putting aside the hawk and dove characterization, some of those names have been much more willing to attack even the law under which the Fed exists. And that willingness for members of Congress to believe that the Fed would come to the rescue and will blame the Fed for the economy's or their own shortcomings, I think would be turned on its head if the Fed ever failed to act. And, I think that to us was a potentially more volatile and chaotic environment where you had less institutional comfort. And I think, certainly a lot of the things that Kevin Warsh had said during and after his term on the board would suggest that he just would have been a little less of an institutionalist.

Beckworth: Yes, well, let me go back to your polling data, and some of the history in this chapter two, which is very fascinating. And you mentioned a few minutes ago that up until 1977, when the Full Employment Act was really, I guess, made law, that it was the Democrats who were the most vocal about their displeasure with the Fed?

Binder: Yeah, and I think that gets back to Mark's point that although theory tells us that the importance of central banks is to control inflation, it's deflation. And really from Democrats perspective, employment and jobs, it has really been the key dimension on which they think about the Fed, and that goes all the way back to the founding of the Fed in the wake of the crisis in 1907… the Great Depression and in the 40s, coming out of the war, right? When employment was doing well, but how are they going to enshrine that importance in terms of the goals of the Fed? How are they going to enshrined that in the Federal Reserve Act?

Binder: That to me, the fact that they get to 77 and the mandate to care about employment and jobs, it was really always there back to 1913, but it gets crystallized certainly in the debates about the Fed. And then once you have that there, I think that helped reduce Democrats incentives to be the ones really leading the charge about the Fed. It's not like they give up altogether. They're certainly there in the 80s during Volcker, but eventually I think Republicans come to understand that their own ideological interests might not be well served by the nature of how the Fed's operating certainly in the wake of the crisis.

Beckworth: Something interesting I learned from your book was an individual, Wright Patman, a Democrat from Texas, and he was the original godfather of Audit the Fed … today we think of the Paul Ron and Rand Paul as audit the Fed champions, but he was a Democrat. And you mentioned he offered 16 audit the Fed proposals, he was a Democrat, and you have a chart, they give us a nice chart in the book. I was just so shocked to see that audit the Fed is nothing new. There's a rich history behind it.

Binder: I mean, that's the nature, a different dimension here, right?

Beckworth: Mm-hmm (affirmative).

Binder: Populists exist on both the left and the right and they've always been skeptical way back to the 19th century about concentrating economic power in the US, right? And so that Wright Patman that the populists were living in the Democratic Party in the 40s and the 50s. He was a longtime critic of the Fed. And keep in mind those audits, they did actually legislate on audits in the 70s. They come up with an audit for everything, but monetary policy, right? They carve it out. Well, Democrats would have loved to have a monetary policy audit.

Beckworth: This is weird.

Binder: Exactly.

Beckworth: There you go.

Binder: But the Senate kind of puts a kibosh on that in the 70s.

Beckworth: Okay. Yeah, it's just striking to see how sides turn, and maybe it'll flip back in the future going forward.

Spindel: Absolutely.

Binder: Yeah, certainly, if the Fed comes to be, it will be dominated by Republican appointees.

Spindel: Sure.

Binder: You could imagine more types of criticisms, and you hear them already.

Spindel: If party control is to change, or does change in the next two, four, half dozen years with that sort of well stocked Republican board of governors. I think, if you believe our thesis, and I think the cycle that we've outlined throughout the book, throughout the 100 plus years of Fed history, I think back to your question of why we wrote the book is we think this recurring cycle isn't going away. And that for political scientists, and for Fed watchers and market participants, it is the elemental relationship.

Beckworth: Well, this is a nice segue into the rest of your book, we get into the history, we'll work through that. But kind of as a bridge between these two discussions, I want to throw out an observation and you guys tell me what you think. It seems to me that there's a reoccurring national distrust of centralized money power in the US, all the way back from, you mentioned Andrew Jackson, the second bank of the US, even Jefferson before that, the first bank United States. All the way through, you highlight some of this, but I think even the most recent crisis, you saw Ron Paul's and the Fed book, we also saw Occupy Wall Street, you see the Fed Up Movement, there's this distrust of, all this power, atypically in the Northeast, New York, Washington, DC, moneyed interest. They're out of touch with Main Street.

Beckworth: I think, Democrats and Republicans, there's elements on both sides that really, whenever something bad happens, I guess, you see this, the other example, the early 80s. Well, Paul Volcker, we'll get to in a minute, but one of the first books I read when I was in college was *Secrets of the Temple* by William Greider. Very fascinating book. A very populist, very strident anti-who are these guys that they can cause pain and suffering throughout the US? It seems to me there's a similar theme through all this kind of visceral, who are these guys who can ruin our lives with a stroke of a pen changing policy?

National Distrust of the Central Banking Authority

Binder: Yeah, for sure. Put your finger on it, right? And the distrust, it crystallizes and comes to the fore when the economy turns down, because, right? That's the purpose for which this Fed and part was created for. And if they're not performing, it's going to rile them up.

Beckworth: So your theory is the manifestation of how Congress deals with that energy that reoccurs?

Binder: Certainly, again, back to the electoral incentives, if the economy's doing well, there's really very little incentive to put your time and attention to it.

Spindel: Well, and some endogeneity, that having a centralized, or increasingly centralized monetary policy maker can help keep those good times rolling along. I mean, I don't think the Fed was sort of absent in terms of helping to create some of those good times. But I'd add, it's not just economic downturns. Again, the institution born of crisis and compromise after the panic of '07, really comes through the way those economic downturns can, and often do filter through the financial plumbing. And I think that centralizing of reserves and reserve management has really been another elemental feature. Part of the weirdness, the strangeness of the institution is you have a board of publicly appointed, presidential appointed policymakers in Washington, but you have still today 100 plus years later, a dozen district banks really staffed and shared ownership, and governance with the private sector with commercial lending institutions in those districts.

Spindel: Certainly, as we talked about in the sort of early history of the institution, it was devolving power from Washington and New York, sort of getting the Wall Street and sort of DC influence out of this Reserve's management and sort of macroprudential function.

Beckworth: Now, tell us more about this. Tell us about the early structure of the Fed, and why it was a compromise of sorts?

The Early Structure of the Fed

Binder: So we had competing factions. We had populist, we had progressives, we had Republicans and Democrats, right?

Beckworth: Mm-hmm (affirmative).

Binder: And we had the wake of the crisis, Republicans lose control after '07, '08 slowly. So we get the first time, Democratic unified party control with Woodrow Wilson coming in 1913. The fight was really some of these dilemmas, right? How much power should be concentrated in Washington, right? Versus how much should be decentralized? And then a different dimension, how much public control versus how much private control? And so you have two dimensions, several factions, and at the end of the day, you end up with a compromise that I think basically creates independence to some degree insulates this institution, right? Not because they, any particular faction wanted an independent bank, but because this was the price of enactment, fine.

Binder:  We're going to give you some more concentrated power with the board. But the cost is, we're going to actually put the power of monetary policy to the extent there was monetary policy, we're going to put that in those 12 Reserve Banks. And then, of course, it's Democrats who are writing the law. And so they have to ask themselves, hey, who's going to get those 12 Reserve Banks because, wow, those are nice to have, I'd like to have one of those?

Beckworth: That was fascinating history you guys put in the book about that, yeah.

Binder: Well, they could have written it in Congress, so they said, hey, let's create a little committee, and let's put the President, Wilson son-in-law in the committee, and two other Democrats, and we'll give them some money, let them go around the country and then take a lot of economic testimony but we know it will be politics at the end. And so you end up with an array, a very decentralized institutions. I think of anything, what was most shocking to me, is this is like a classic case of what we call path dependency. You embed in statute these decentralized institution, and those Reserve Banks, they fight for their power. So that today, 100 years later, right? We got two banks in Missouri. What? You tell me.

Beckworth: Right, and they're not going anywhere.

Binder: They're not anywhere, right?

Spindel: One bank for the entire sort of western half of the United States.

Beckworth: That was super fascinating. It was the Reserve Bank Organizing Committee. I wasn't aware of this history or this part of their formation, but it was my understanding this was always political, and I was surprised to read in your book that many other scholars think it wasn't so political. But you guys showed that it was political, at least part of it, the process.

Binder: Was it? Yeah, I mean, we try to map out, if it was pure finance, what's the financial map? What would it look like? And there's some certainly all the big reserve cities Chicago, St. Louis, New York, right? Boston got Reserve Banks. But they're 12 banks, and so if we think about what's the partisan map look like? Well, the odd part is that there are several banks, Reserve Banks put in the south, right? Atlanta, Dallas.

Spindel: Richmond.

Binder: Richmond, right? 1913, 1914, there's not a lot of economic activity going on there. But it's also a solid Democratic self, and so it's a little hard to disentangle, right? The partisan geography. But we try to show that in fact, there were other cities clamoring for banks, and they were Republican cities. Denver, for instance, elsewhere on the west coast, certainly Baltimore, but they didn't get the banks.

Beckworth: It's interesting, and I think it's a good point. I mean, Atlanta and Dallas weren't big cities back then. I mean, the air conditioner hadn't come along yet, a lot of reasons why those cities. Now it seems maybe somewhat obvious. But the other thing is just the concentration, right? And I guess there wasn't a lot of population out west but you mentioned Kansas City actually made sense. It wasn't just politics, right? Kansas City?

Spindel: Right. I think *The Myth of Independence* and monetary politics, as we said, at the top, it's a subtle distinction. I think some of the surprising elements that those dozen banks, the 12 district banks have not moved in 100 years despite a sort of enormous sort of change in sort of economic activity in the US. And I think what may have been underappreciated in the political nature of the sort of initial scaffolding, is how that broad national support that, there are lending institutions throughout the West Coast who have a relationship with the Federal Reserve Bank in San Francisco, there are sub delegate offices in Los Angeles that deal with sort of community bankers and borrowers throughout, for example, California. And when the institution has been challenged, particularly, either economically, politically, it's easy for the Fed, and we heard this in talking to members of the board.

Spindel: That they can reach out to these community bankers, the auto dealerships, the developers, and that fabric that was established in the wake of the '07 crisis and led to the founding, and we think the survivorship of this particular, this third iteration of central banking, goes to that broad compromise.

Beckworth: So it's unlikely that the structure is going to change anytime soon.

Binder: So there was an effort in Dodd-Frank. Dodd really wanted to centralize supervision, and gin up the Reserve Bank presidents and there's a little controversial from the reporting at that time, but at least four of them with Fisher from Dallas, and a few of the St. Louis and a couple others came to Washington and as best we can tell, were lobbying to explain why it so important to keep, even though they-

Beckworth: The presidents themselves came up.

Binder: ... The presidents themselves, right?

Beckworth: Wow. That's shocking.

Binder: But that's this path dependency. Where once you establish power in these institutions, it's really hard. And then there was a floor vote, right? Who was the first on the floor, right? Hutchinson, Senator Hutchinson from the Dallas Bank.

Beckworth: Oh, from Texas.

Binder: And then, oh, Claire McCaskill, I think must have been, wasn't far behind. She's got two to defend.

Beckworth: Well, that's fascinating. There's so much history here. I won't have time to do all, but I want to go back just a little bit on the early structures of pre-Great Depression, the 12 regional banks were effectively, as you mentioned, there wasn't a whole lot of monetary policy going on. But to the extent there was, it was being done individually by these 12 banks, and they were constrained by the gold standard, and there was some effort to coordinate, but you mentioned in the book, they often disagreed, and they often were getting these contests with each other. And then we get to the Great Depression, and you kind of recite in Milton Friedman's version of the Great Depression, that one of the reasons it got so bad is because you had this very decentralized system. And it may be Benjamin Strong had been alive, he could have coordinated an effort.

Beckworth: But let me throw something out there. There's an economic historian, Hugh Rockoff. He's a big monetary economic historian. He did a paper looking at when did the United States become an optimal currency area? Which means, does it make sense to have a one size fits all monetary policy? And this is a big discussion going over in Europe right now, right? Is the Eurozone truly an optimal currency area. And he argues, it really wasn't until the 1930s when all the New Deal policy.

Beckworth: So some of the arguments for an optimal currency area is, ideally, you'd have the same business cycle across the entire currency union, because you apply one size fits all can cause problems. But if you don't, you can still have it, as long as there's some kind of shock absorber. So there's labor mobility, or there's these fiscal transfers of Michigan gets hammered by the Fed, Texas is prospering, income taxes are collected and sent up to Michigan to kind of soften the blow. And he argues really, it's not till the 1930s, we have all these New Deal institutions in place that you can consider the US a true optimal currency area. And so if we take his argument as given, then in some ways it makes sense, you'd have 12 different little monetary policies. Again, I know they weren't hyperactive, but maybe they responded uniquely to their unique environments. Now, it caused a problem, the Great Depression, but what do you think of that?

The US as an Optimal Currency Area

Spindel: Right. I think you kind of hit the nail on the head. That if they had the kind of tools, creativity, some of the learning in macro and microeconomics and central banking over the last 70 years, perhaps, but I think they were hamstrung by just an absence of tools, some sort of sub challenges and in putting in place some cases, some sort of hard money policies that I think were not so helpful. But indeed, when you sort of look at the actions of the Federal Reserve, and its own kind of self-analysis, there were, I think it wasn't really until both a huge fiscal stimulus and the devaluation in the gold standard, And then a reevaluation of the act in the mid-30s, ultimately, the Banking Act of '35, where they really changed the complexion of monetary policy, centralized that with the establishment of the FOMC. I think that that began to bring all of this-

Beckworth: That's when the Fed becomes truly itself. Now, so the Great Depression is when power begins to become consolidate, the Board of Governors is created and we'll get to the treasury coordinate a few minutes. But the interesting amendment that I learned from reading your book is the Thomas Amendment in 1933. So, Sarah tell us about that a little bit. That was very fascinating.

The Thomas Amendment

Binder: Sure. So then, think of it, we're coming out of '32, '33, we have electoral change. But the question really from members perspective, given that there are pressures on the gold buggers versus the people who want to coin silver as sort of the bimetallic standard, lots of discussion about how currency should work. Certainly you have southerners who were Southern Democrats who hold a majority here within that conference caucus. They're concerned about farm prices, obviously at the wake of depression.

Binder:  So the question is, where should power lie? And the decision remarkable from today's perspective is, let's give that power to the President, right? And that's really what the Thomas amendment did. It didn't really require the president to act, but it empowered him, empowered the president to do it. That's really what Thomas Amendment does, and then opens up the way, the next year they have the Gold Reserve Act. The Gold Act, where they've essentially allowed the president to devalue...

Beckworth: Yeah. So the spirit of the law, if I understand it correctly is, is look if the Fed's not going to do anything, we're going to take policy in our own hands. I mean, Treasury, FDR, we're going to make the move, and was this the law that justified FDR's devaluing of the gold?

Binder: So that was '34, and along with it, they created the Exchange Stabilization Fund and Treasury, which really was, again, from today's perspective, astounding, right? To basically allow Treasury to conduct monetary policy.

Beckworth: Yeah, yeah, exactly.

Spindel: It was absolutely a competing element.

Beckworth: Yeah. Interesting you document in the book that the board was actually nervous about the Exchange Stabilization Fund all the way up into the 50s, when the Treasury Accord is being discussed?

Binder: Yeah, and Morgenthau was Treasury secretary would threaten. I do have this. So I'm sitting here, so.

Beckworth: So we can take the reins back from the Fed, and run monetary policy out of the Treasury Department?

Binder: Yeah, and it leads in part to the episode of 1951, which has become this sort of existential moment that we...

Beckworth: So a question, and you may not have the answer to this, but can the president still invoke the Thomas Amendment? So remember the platinum coin, could President Obama have invoked the Thomas Amendment to have done the platinum coin? Or is that law limited to the earlier periods?

Spindel: I think the exploration at the time suggested that it technically could have been put in place, but I think, practically was not-

Beckworth: Right, it would have been very controversial, for sure but...

Spindel: Right, but as Sarah and we sort of talked about the sort of empowerment of Treasury, the Fed's willing, in some cases, willing subordination. I mean, up until the Employment Act in '46, and then ultimately, the 1951 Treasury-Fed Accord. The Fed was sort of willingly, obviously, to finance the war effort, subordinating monetary policy, underwriting Treasury debt, doing all sorts of things in service to the executive branch, and all the way back to the notion of the myth of independence, people look at 1951 just a decade and a half later as the point at which the Fed became independent.

Spindel: But what we tried to document in the run up to '51, and everything that's happened since is the dependency or the boss shifted from the executive branch and Treasury back towards Capitol Hill where maybe they've been just all along.

Binder: All right. I mean, the '51 it's sort of interesting. The excellent economic history here, but it's all about a deal. But really there was no deal. We call it a divorce, right? Between the Fed and Treasury.

Beckworth: And Treasury, yeah.

Binder: And Congress really was the one with their finger, I think there's a threat that they would legislate. the Paul Douglas, the senator was ready to legislate to separate debt management for monetary policy and Treasury didn't really seem to want that in statute per se. I think everyone benefited from some flexibility and the threat that Congress would actually legislate seemed to help empower the Fed to stand up to the president, right? Let alone Treasury in divorcing.

Beckworth: Yeah, very fascinating. I hadn't known about that either, this Douglas report that it really is kind of a showdown at the, OK Corral between Congress, Congress and the Fed's is sitting next to and theirs Treasury at the other side and they were about to pull the pistol up but they didn't and Treasury backed off but it needed Congress's support. That's the story you guys tell that isn't documented elsewhere.

Beckworth: Well, let's move up to the great inflation because we're running low on time. Let's move to Paul Volcker, okay? That's fascinating. That's kind of where I cut my teeth. I mentioned I read *Secrets of the Temple,* and he's kind of like the patron saint of central banking. He's the hero of the day. But tell us what the more nuanced story that you guys tell in the book.

The Nuanced Story of Inflation and Paul Volcker

Binder: Well, I mean, Volcker is the classic example of people point to for Fed independence, right? He slayed stagflation.

Spindel: 20% rates. Got what he wanted.

Binder: But the more you dig into it, in this case, the FOMC transcripts of what was being debated, you see that the power of the Fed was limited by what they thought the public in Congress would support, and certainly in the White House, right? Which was actually early in the years, their supportive of Volcker. And you hear it and keep in mind, so late '79, '80, '81, we did not yet in this time have published transcripts of the FOMC. In fact, that was until '94, '95. And it doesn't appear that members of the FOMC understood that they were or there could be transcripts. And so they're quite honest about the political limits under which they're making monetary policy and every session, are we there yet? Are we there yet? Right? And then they start talking, well, we got to be careful otherwise, there will be legislation, and Volcker's very clear about the political limits, as previous...

Spindel: I mean, and within those limits, again, he got what he wanted. He got rates to 20%.

Beckworth: Okay. So, Congress is the guardrails. Only so far you can veer.

Spindel: But the conditions that created that somewhat self-inflicted. I mean, I think the Burns's diary, again, sort of what led to the run up and his own resubordination of his policies to the executive branch. I think, sort of set in stone this need to have someone come in, such as Volcker. But it really is the exception, this idea that the Fed's independence is there to protect this kind of shorter temporal inflationary concern as we've talked about today. It's really been a disinflationary, deflationary financial crisis type of mandate for most of the 100 years.

Beckworth: So, Volcker did face some serious blowback, some serious grief on Capitol Hill. But I think you're arguing that he couldn't have done that without the implicit support of, Congress knew something had to be done, and so you have that side but then you also have the fact that Volcker was a hated man for a while. I mean, what I've read is they were like, this is the first time that the Federal Reserve first really gets security, they get serious, a guy had stormed the FOMC, with a sawed off shotgun, wanted to hold the place. The fact that he could just run in is shocking. But even going before Congress, he got a lot of grief. So, they gave him grief, Congress gave him grief, but they also gave him some free rein. Is that right?

Binder: Yeah, and keep in mind, we have massive electoral change in 1980, not just Reagan being elected, but Democrats lose control of the Senate. And that produces some buffer, I think, for slaying inflation, right? Versus what Democrats in charge of both institutions had been saying, which is, don't throw us into a recession here. So you get a buffer there, and you still have a broader mix of ideologies within the Democratic Party in 80s. So you'd have defenders, Senate Democrats, Proxmire or others, right? Defending the Fed's ability to do what Volcker wanted to do, and certainly in the White House with at least implicit support from Reagan and Shultz.

Beckworth: Yeah. Well, in your book, by the way, there's this chart there, your poll of the Fed, and maybe it's Volcker, maybe it's the Fed, but he has one of the highest ratings in the mid, '85, '86 periods. So he was loved afterwards, but at the time, he was not a very popular person, right? No.

Spindel:               20% interest rates.

Beckworth: Yeah, well, it's the price to pay to get back to low inflation. Well, let's move forward into the most recent crisis in the time we have left. We've touched on it already. But it was very striking to me, I mentioned For example, this senator that I saw, this was around 2010, by the time, QE two is coming out, and one of the things that happened to Bernanke at that time as I recall was he was being grilled about how he's debasing the currency, we're going to be the Weimar Republic again. And if you look at the actual data, core inflation was all over 1%, reality versus rhetoric was very, very different.

Beckworth: So that's shocking, but then I understand where maybe some of the folks were coming from in the following sense. We just went through the Great Recession. I mean, shocking, massive, contraction activity. Obama does a massive fiscal stimulus, which some find startling and then on top of that the Fed's doing QE one, now wants to do QE two. All these things were just really new. There were novel back then, right? Today, we're like, okay, it's something the central bank does. So could that have been part of the story, people were just freaked out that there's so many new things being tried and wanted to go after Bernanke for that?

Public Skepticism of the Post-Great Recession Fed

Binder: Well, sure, right?

Spindel: Sure. Yeah, they were definitely freaked out. And I think, the notion of money printing, the expansion of the balance sheet, low and lower and zero interest rates. Yeah. I mean, there were a lot of crank ideas and crank concerns. I mean, as you pointed out, none of them really came to pass. But, I think, with slightly different cohorts, but the balance sheet, for example, which is, in many ways, it's sort of the heart of central banking, the buying and selling of, for the most part government bonds. But we had some pushback, for example, from the House, the current soon to be retired chairman of the House Financial Services Committee, Jeb Hensarling waved his finger concerned that our central bankers would become our central planners. Part of the clipping of lender of last resort ability in Dodd-Frank, sort of went to the ability of the Fed on its own to lend money.

Spindel: So I think the creativity with those tools, low, zero interest rates, forward guidance, certainly the balance sheet, Bernanke himself said that, these were tools that had not fully been tested, and rolling them out gradually was probably the way that he needed to do it. But I think looking back the efficacy of what they did is, it's both hard to argue with but also easy to imagine a sort of challenge or a higher hurdle for the next chair faced with those kinds of conditions.

Binder: Keep in mind that some of the bond buying was criticized for being more fiscal policy than monetary policy, right? Once you started buying up housing debt, right? And that is sort of the question. If the boss isn't going to act on the fiscal side, the Fed seems to understand that it was in their remit to take those actions. But of course, the cost is, as Mark just said, right? All those options is going to be available. So that Bernanke playbook, can they run it again?

Spindel: Yeah. If the Fed were to be told that it can no longer purchase GSE agency debt, which was a direct way that the Fed decided they could stimulate the housing market through bringing interest rates down, what would they do? But that mandate of what they can buy is in law, and that law is written by members of Congress. And so for all their frustration they haven't yet seen to take this.

Beckworth: What Congress can create, Congress can take away at some point. Well, let's move to something else that's very topical right now, and listeners will know and probably are sick of me saying this, but I'm a big fan of nominal GDP level targeting. I think we're a long ways from that ever happening. But there's been some push for one higher inflation target to maybe a price level target. At least some people have been talking about it. Some regional presidents have talked about it. And Mark, you shared an interesting, a link to a video on Twitter, that shows how people like me who think about and other Fed watchers, maybe some of us who dream about it, is a better word, how precarious such hopes are based on the fact that this interdependent relationship between the Congress and the Fed. So speak to that video that you shared and what it says.

Feasibility of Nominal GDP Targeting

Spindel: Right, I would say there's been a strong chorus, even Bernanke he himself four or five weeks ago had put out a paper talking about sort of changing the Fed's target. The book outlines the decade it took him to put the 2% target in place and with the persistent lowflation over the summer, you had had four downside surprises in the CPI report. And there were another series of calls from members and former members of the FOMC to adjust the target, perhaps raise it a bit and change the reaction function and the path of potential rate hikes.

Spindel: Chair Yellen was asked directly by chair Hensarling, her boss on the House side, whether there was any truth to the rumors that they were considering a change in the target, and she gave a very clear answer that, no, they weren't. And Hensarling's response was I'm going to take that, no, for an answer. And again, the threat that Sarah and I have talked about today was very clear, don't you dare change that target without my permission. And so I think, the link is sort of a contemporary version, a contemporary example of what you're saying. That despite all the maybe macroeconomic efficacy, the blurring between goal and tool independence is a target, sounds like a goal but if you can adjust it, it's got a lot of tool qualities to it. But don't forget who the boss is. And I think working with the boss as Chairman Bernanke did in the 10 years again, it took him to put that in place, sort of goes to the heart of who really governs the Fed.

Binder: Man, and keep in mind, we're in a world here, not that what theory tells us about the need to constrain inflation is precisely the opposite and the politics, it matters here, right? And certain politics come along with this, and certainly when you have ideological conflict in Washington, and partisan conflict in Washington, we see that played out in these interactions between the two institutions. So this notion that the Fed has the autonomy to set the instruments, it's really hard and I don't think members really see the difference between goals and instruments, right? They see outcomes. That's what they're judged on.

Beckworth: So I'm just a dreaming fool, huh?

Binder: The bugs look good, though.

Beckworth: I guess that's why I do what I do is hopefully I'm in the margin, we're informing debate, this show, our research and so forth, that maybe eventually we convinced the boss, Congress and maybe the people who elect Congress but that is a long haul.

Spindel: Absolutely.

Beckworth: Well, this has been fun. Thank you guys so much for coming on.

Spindel: Thank you very much.

Binder: Sure, thanks for having us.

Beckworth: Our guests today have been Sarah Binder and Mark Spindel. Thanks again for coming on the show.

Spindel: You're very welcome. Thank you very much.

Binder: Thanks.

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