I was in the room when President Bill Clinton decided to reappoint Alan Greenspan, a lifelong Republican originally appointed by Ronald Reagan, as chairman of the Federal Reserve Board. A political adviser urged Clinton to choose an administration ally, but that was never seriously considered. The president’s choice was not determined by party, or politics or ideology.
That’s how it has been for decades: Federal Reserve chairmen and governors have been selected based on their ability to serve the country. President Barack Obama reappointed George W. Bush’s nominee, Ben Bernanke, as chairman. Reagan reappointed Jimmy Carter’s nominee, Paul Volcker.
The Federal Reserve System was created by statute in 1913, but the independence of its monetary policy from congressional or presidential influence is not codified by law — and it wasn’t always inviolable. In recent years, so-called reforms have been proposed to subject Fed monetary policy to congressional review, but its independence has so far been preserved.
For good reason: An independent Federal Reserve led by governors who are committed to pursuing its dual mandate of price stability and full employment, as well as effective regulation — and who make decisions based on facts and analysis — is critically important to our economy, the well-being of the people and the market credibility of Fed policymaking.
But that independence is about to be severely tested. Daniel K. Tarullo stepped down from the Federal Reserve Board last week, adding to the board’s two existing vacancies. Instead of remaining as governors, Chairwoman Janet Yellen and Stanley Fischer, the vice-chairman, could step down when their terms expire next year. President Donald Trump has already said that he will not reappoint Yellen as chairwoman because she’s not a Republican.
Trump could therefore fill as many as five of the board’s seven seats within the next year. I fear that he may appoint governors who lack a commitment to the Fed’s dual mandate and will instead seek to please the White House.
Troubling sign
There could also be an effort to scapegoat the Fed if (or rather, when) the administration’s unrealistic economic growth estimates fail to materialise. The recent rejection of Congressional Budget Office health care estimates is a troubling sign. The administration could use rigged economic projections to attack the Fed over its decisions, rather than respecting its integrity and independence.
The Fed is not always right — no one can be on these matters. But it is staffed by, and the board consists of, immensely capable professionals who work with absolute intellectual integrity. That’s why the Fed’s work is highly and widely respected in the US and around the world. This credibility keeps market interest rates lower and liquidity greater. That, too, could change.
Efforts to denigrate the integrity of the Fed’s work, and to inject groundless opinion, politics and ideology, must be rejected by the board; and that means governors and other members of the Federal Open Market Committee must be willing to withstand aggressive attacks.
In the short run, these attacks could occur if the Fed raises rates when the administration would prefer to avoid impediments to its wishful thinking on growth or to the continued run up of the stock market. The Fed is expected to raise rates two or three times during the coming year, based on its widely shared view that unemployment is as low as it can be without triggering inflation.
There is undoubtedly still some room to bring those who have dropped out of the labour market back in, but mainstream labour economists say not much, especially given the skills gap.
The path to greater growth over time is productivity-enhancing policy. While a small fiscal stimulus might increase real growth and wages, a highly expansive fiscal policy is very unlikely to meaningfully increase real growth, and the rest of the effect is likely to be inflationary, absent countervailing Federal Reserve action.
Political backlash
Waiting until inflation gains momentum could force the Fed to take more dramatic action that could induce recession. With the administration’s unwillingness to appreciate these realities, Fed rate hikes could provoke political backlash.
During my years as secretary of the Treasury, I had a weekly breakfast with Greenspan and Larry Summers, the deputy secretary. We discussed everything under the sun, from the outlook for the US economy to the latest political gossip. But never once did Summers or I, even in the privacy of those meetings, raise monetary policy, nor did anyone in the Clinton administration comment on monetary policy.
As a result, the Fed chairman knew that the White House would not try to advance an agenda on that policy. And this trust enabled the Federal Reserve and the Treasury to engage fully with each other on other matters, such as the Mexican and Asian financial crises. Sooner or later, there will be other financial crises — in the US and abroad — and maintaining a framework of trust for the Treasury and the Fed to work together is critical.
The administration’s relationship to the Fed, and its appointment of governors, must be based not on politics but on the same question every president ought to ask: Who and what will best serve our country?
