The Democratic People’s Republic of U.S. Monetary Policy

In a post-Great Recession world, monetary policy just looks different. For one thing, central bank independence is dead—but the U.S. Congress doesn’t know it yet. We could argue for hours, or days, about whether it ever really existed or when exactly it died, but suffice to say that the moment quantitative easing started, the Federal Reserve stepped out of its well-defined monetary box, and independence was no more. Central bankers know it: In a recent survey, 61 percent of former central bankers surveyed from around the world predicted that central banks would be less independent in the future.

The U.S. Congress has not acknowledged this reality. Members of Congress depend on the doctrine of central bank independence to keep the dirty business of monetary policy off their hands. The question is whether Congress will continue to ignore reality and let the Fed take on more power—and increasingly fiscal rather than just monetary—over the economy or whether it will choose to step in, reassert its political power, and get more involved. Most important of all is a question no one seems willing to ask: What might the answer to this question say about the state of U.S. democracy?

The Fed’s policymaking power comes from its congressional mandate “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” That’s a pretty vague mandate. Imagine the range of policies that might influence employment, price stability, and interest rates: job creation, education, health care, climate change, electoral politics, the list goes on. Prior to the 2008 financial crisis, the Fed’s delegated powers were restricted by a set of informal limitations. Namely, the Fed, an independent central bank populated by experts, would execute monetary policy according to internationally accepted best practices. But the crisis exploded the conventional consensus on best practices and, in so doing, broke the restrictions on the Fed’s power. That’s a problem. As Paul Tucker, a former deputy governor of the Bank of England, wrote in 2018, without clarity on the limits of their power, central bankers would “be incentivized to do whatever is needed to deliver their mandate, however far that reaches into fiscal territory.”

One of the initiatives they tried during the financial crisis was quantitative easing. After conventional approaches, like manipulating the short-term interest rate, proved insufficient, they turned to QE. QE is a form of large-scale asset purchase in which the Fed buys a huge number of longer-term government-backed securities using newly created central bank reserves in an effort to change the contours of the market. Although the world is a decade past the crisis, central banks have struggled to restore conventional policy. The post-2008 economy is not like the pre-2008 economy. In particular, policymakers are staring down the barrel of persistently low natural real interest rates and the realization that inflation seems to be determined more by inflation expectations than by real economic slack. The upshot of this new economic environment is that, from now on, conventional monetary policy will not be sufficient to maintain price stability.

In June, the Fed convened a conference to address the problem. In his opening remarks, Federal Reserve Chair Jerome Powell posed three guiding questions that can be summed up in one: How can the Federal Reserve continue to reach its stated aims in the face of this new economic environment, taking existing governance structures as given? He went on to suggest an answer: “Perhaps it is time to retire the term ‘unconventional’ when referring to tools that were used in the crisis.” This was more or less the prevailing theme of the entire conference: Make the unconventional conventional. In other words, quantitative easing will be part of the new normal. That’s already started to happen. Take one example: The New York Fed recently implemented large repurchase agreement operations, essentially launching a targeted version of QE to prevent the collapse of one far-away corner of the financial markets with a liquidity problem. This has gone largely unnoticed in the public domain.

There are two ways to interpret the Fed’s so-called normalization of the abnormal. It is either a power grab or an administrative agency doing its best to fulfill its congressional mandate in a new economic environment. In reality, it is probably both. The fact that such blatant overreach is necessary should perhaps tell us something about the job itself, the state of the economy, and the state of the U.S. democracy. Under either interpretation, Congress is shirking its responsibility to govern the macroeconomy by allowing the Fed to redraw the boundaries of its own policy jurisdiction.

Money is the stuff of our collective life. It is what binds us together as citizens; it determines who is permitted to do what in society, what society values, what it wishes to create, and much more. Money represents our social, economic, and political interdependence. The central bank is not the only institution that creates money. Banks do. Every time a bank extends credit, it creates money. The Fed’s power over the money supply, then, is not all about choosing how many dollars to print. In large part it comes from the Fed’s ability to incentivize banks to extend more or less credit, on easier or more stringent terms. Right now, the Fed’s monetary authority—the Federal Open Market Committee—is made up of only 10 people: All are white, none are elected.

Both conventional and unconventional monetary policy involve open market operations, in which the Fed executes monetary policy by buying or selling assets on the so-called open market. The use of the term “open market” here is a bit misleading. Whenever the Fed buys and sells Treasurys in order to execute monetary policy, it interacts with a predetermined set of primary dealers. There are about 20 designated primary dealers at any given time. The list changes fairly regularly and is not limited to U.S.-owned financial institutions. Today’s primary dealers include BNP Paribas; Barclays; Bank of Nova Scotia, New York Agency; BofA Securities; Citigroup Global Markets; and Goldman Sachs, to name a few.

The expectation is that the Fed’s buying and selling Treasurys to and from primary dealers will stimulate the entire economy. The enormous asset purchases the Fed made from primary dealers as part of QE were meant to encourage investors to put their money in riskier assets and thereby reduce the cost of borrowing across the economy. It was up to the investors, of course, to decide which assets to invest in, when, how much, and why. In sum, trickle-down economics is alive and well in U.S. monetary policy.

To see how, consider that when the United States creates new money, whether through QE or more conventional channels, it disseminates that money through private financial institutions run by individuals who are extremely rich and are explicitly profit-seeking. These financial institutions decide how much money to create, whom to extend credit to, and on what terms. These same private financial institutions have a history of disseminating credit to the rest of the population in a highly lopsided manner. The U.S. approach to governing money leaves much to be desired. The public does not decide democratically what it values or wishes to create—instead, it lets Fed officials and private financial institutions do that on its behalf.

The Fed’s recent efforts to normalize QE will only make things worse. The locus of power over monetary policy is drifting further and further away from the people and their elected representatives. This poses a threat to U.S. democracy. That should be no surprise, really, because it means unelected bureaucrats taking on more power and responsibility while elected officials continue to shirk.

Perhaps this system is the best option. In today’s world, one must at least entertain the idea that a good bureaucratic policy is better than a bad democratic one. From one vantage point, technocratic monetary policy has come to the United States’ rescue, especially when contrasted with the Trump administration’s abysmal policies on the environment, taxes, the provision of public goods, and more. The Fed, for its part, is starting to focus more and more on the fight against inequality, and elsewhere in the world central banks are beginning to turn their attention to addressing climate change. To steal a phrase from a recent opinion piece in the New York Times, civil servants are sexy—“they are heroes of the resistance.”

The idea of the heroic bureaucrat is not new in monetary policy, a sector dominated by the idea that expert technocrats can implement optimal policy. As four former Fed chairs wrote in a piece in the Wall Street Journal this past August, “History, both here and abroad, has shown repeatedly … that an economy is strongest and functions best when the central bank acts independently of short-term political pressures and relies solely on sound economic principles and data.”

Good technocratic monetary policy, in other words, is not an opportunity to be missed. It is a unicorn in economic theory: a free lunch. In the short run, according to conventional theory, monetary policy can be used to stabilize aggregate demand to meet aggregate supply, thereby dampening business cycles and achieving price stability. In the long run, monetary policy is nothing more than deciding the price of money, thereby influencing how much money is in the system—if bread costs $1 or $100. Monetary policy is assumed to have no lasting effect on output or unemployment and, thus, no real cost. The conventional view can be summed up as follows: Fiscal policy is what shapes the real economy; monetary policy merely matches it. Or as one Bloomberg commentator put it, “the point of the Fed is to read and react.”

This is all very neat and tidy, but what does monetary policy acting only to match the real economy actually look like? It’s more complicated than you might think. Take the example of U.S. President Donald Trump’s recent war with the Fed. Trump is not only berating the Fed on Twitter, he is also creating an economic world in which his coveted lower interest rates actually make sense. His trade war with China has contributed to an economic environment in which the Fed, relying “solely on sound economic principles and data,” would likely lower rates. Trump has contributed to the development of an economic situation in which, on the numbers alone, it makes sense for the Fed to what exactly what Trump demands it does: lower rates.

In such a situation, what should the Fed do? Should it comply? Or should the Fed refuse to play along with the president in pursuit of longer-term price stability—that is, not lower rates to avoid a trade-induced economic disaster? The latter option was the forceful suggestion of former New York Fed President and CEO William Dudley in a now-infamous Bloomberg op-ed. Dudley went on to suggest, “There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy.” Let’s be clear about what this former Federal Open Market Committee member is suggesting: The Federal Reserve, the independent central bank of the United States, should interfere in the nation’s general election. Here we have a direct conflict between good bureaucracy and bad democracy—the good bureaucrats correcting for bad democratic impulses.

As much as observers fretted over the idea that a foreign power could, and had, interfered with the integrity of the U.S. election system, fewer were outraged by the idea of the Fed interfering. Sure, Russia is a foreign power, and the Fed is a U.S. institution, but when it comes to the integrity of the democratic system, that distinction should not really matter. What is the difference, after all, between a sexy bureaucrat and a benevolent dictator? Both are unelected officials who some set of observers think are doing the right thing.

To be sure, it is inevitable that some policymaking power will be delegated to bureaucrats. There will always be unelected officials making policy decisions that influence citizens’ lives. This is no threat to democracy, so long as ultimate political power remains with the people and their elected representatives. But if those officials delegate immense power, in perpetuity, with no intention of ever reevaluating the terms and conditions of delegation, then delegated power starts to look increasingly like usurped power. The unelected bureaucrat starts to look more like a dictator—benevolent or not.

Today’s political environment is forcing voters to decide how much they really care about democracy as such. To properly answer this question, it is important to separate out the following two questions: Who should decide on policy? And which policies should be implemented? For those who believe that democracy is of fundamental importance, the who question must be prior to the which matter. In today’s political environment, that means swallowing some awful policies—the Muslim travel ban, the 2017 tax cuts, putting children in cages, and much more.

Given the fundamental importance of democracy, Congress should take its fingers out of its ears and reassert its political power over monetary policy. Some might like to see U.S. monetary policy used to fight inequality, the perils of climate change, and existing biases in credit allocation under the watchful eye of Congress. Others might want it to promote political goals such as building a wall on the southern border. In a world in which Congress wakes up and governs the economy, rather than leaving it to the Fed, selecting from among those policies would ultimately be in the hands of the people. That is a risk those who believe in democracy should be willing to take. If the people are allowed to choose only when they make the right choices, then the United States would not be a democracy. It would be something more like the Democratic People’s Republic of U.S. Monetary Policy.