The Power and Independence of the Federal Reserve

Book Preface

There is an old story, perhaps apocryphal, in which the Fed Chair greets a newly appointed member of the Board of Governors of the U.S. Federal Reserve System with an apologetic explanation of the new governor’s status. The chair predicted that when the man introduced himself back home to his friends and family as a “governor of the Federal Reserve,” they were likely to think he was the administrator of the U.S. government’s unexplored western forests.¹

There was a time when that story was amusing. The Fed used to be an obscure, backwater government agency. The general public didn’t really know what the Fed was about and probably didn’t much care. Even for those who paid attention to the economy, until roughly the early 1960s the prevailing view was that the president and his administration were the first and last stop for economic policy. Central banking was in the hinterland; fiscal policy—the stuff of taxes and budgets and spending and deficits—was at the core. Bankers cared about the Fed’s obscure activities. The rest of the country wasn’t paying attention.

That story used to work. It doesn’t any more. Today, it’s not just bankers who are paying attention. Over the last thirty years, and especially since the global financial crisis of 2008, the Fed has become the target of an extraordinary proliferation of scrutiny, praise, and condemnation. Today, it is not an exaggeration to say that in the popular imagination and in fact, the Federal Reserve sits atop the global financial system and, indeed, the global economy, in a way that no institution has ever done before. “We are going through a period with no precedent in American history,” Alan Greenspan said in 2014 of the Fed’s brave new world. And he’s not the only one who has noticed.²

But where public knowledge of the Fed’s existence has dramatically improved—people know the Federal Reserve deals with money, not forests—public knowledge of the Fed’s structure and functions has not. The problem is not simply one of public ignorance, though there is plenty of that. The problem is that the Fed is one of the most organizationally complex entities in the federal government, with some of the most varied missions to accomplish tucked inside. The core questions about the Fed—how it is structured, who pulls its many levers of power, and to what end—are cloaked in opacity. Even the experts who study the Fed are left confused by the set of institutions that has survived the Fed’s sweep through a century of history.

This book is an effort to cut through that morass of law and history. The focus, as the title indicates, is especially on how the Fed gained and uses its extraordinary power over the global economy and what is meant by the often invoked but rarely explained term “independence.” “Power” here refers to the incontestable fact of the Fed’s ability to influence every individual, institution, or government that interacts with the global financial system. If you have a mortgage, a car payment, or a credit card, the Fed had power over its terms. Every foreign government in financial crisis has felt its influence. Private banks are deeply connected to the Federal Reserve System. And as we all saw in the 2008 financial crisis, policy failures and triumphs within the Federal Reserve stirred financial havoc but likely spared us from financial cataclysm.

As we shall see, central bankers love metaphors, so let me begin this book with one of my own. My six-year-old son spends a lot of time writing and illustrating comic books whose quality long ago left me in their artistic dust. But when the heroes and villains fight, as they invariably do, the details defy even his artistic ability. He hasn’t quite mastered the depiction of motion in two dimensions, and his protagonists inevitably disappear behind a mass of scribbles. Occasionally a head or a limb will sneak out from behind the bustle of color, but the fight itself is never for the viewer to glimpse in detail. We see only what goes in, who comes out, and that something dizzying happens in between.

Many discussions of the power and structure of the Federal Reserve occur behind a mass of scribbles. There is enough that we can see sticking out of the commotion to create common assumptions to support a debate—a reference to central bankers’ long tenure shows up here, the Fed’s budgetary autonomy sneaks out there, public opprobrium for politicians who attempt to dictate monetary policy makes an appearance, as does fear that central banks are wresting control of fiscal policy. But so much about these fundamental concepts of public governance occur behind an inscrutable mass.

This book steps behind the scribbles to depict the Federal Reserve, its internal structure, its external pressures, and the technical and nontechnical ways it makes its many policies, with more clarity than these questions usually receive. One of the barriers to this clarifying effort is, ironically, the very enthusiasm this subject creates in those likely to read a book titled The Power and Independence of the Federal Reserve. This is especially true in the years since the financial crisis of 2008. There is a strong temptation to become, as the epigraph suggests, “eager disputants” who demand an answer on where the author of such a book stands with respect to the Fed’s virtues and vices, its independence and accountability, indeed its very existence. For such readers, these are yes-or-no questions. Anything more seems an equivocation.

This book is an effort to push back against the certainty of those absolutist narratives. To understand the unique place the Fed occupies at the intersection of financial markets and the U.S. government requires a dive into the very meaning of this curious intellectual and institutional construction, Federal Reserve independence. But trying to make sense of the Federal Reserve and its extraordinary power with yes-or-no questions about “independence”—is the Fed independent? Should it be independent?—is an impossible task: “independence,” I argue, is a concept without much analytical content. This book argues instead that we must go deeper before we can draw the Fed out from behind this veil of mystery where it has so long remained. To put the point differently, before we can judge the Fed, we must first understand it.

Of course, this is not the first book to explain the Fed generally or even Fed independence specifically. The central bank has long been a subject of fascination for economists, journalists, historians, and others. This book relies on these extensive previous efforts. But it is also different. Using insights from law, history, politics, and economics, this book aims to give a deeper and more complete view of what the Fed is and how it became this way. The book’s main comparative advantage is its grounding in law and history. Legal scholars, with important exceptions, have not paid much attention to the Federal Reserve; historians, too, have essentially ignored all but its creation in 1913. While this book is more a work of legal scholarship than history, I hope to persuade all readers—whether lawyers, historians, economists, political scientists, or members of the general public—of the value of looking at this old structure with new eyes. The ambition is to perform a scholarly exchange: by bringing insights and observations from multiple approaches, we can better understand what the Fed does, why, and whether we have the central bank that we want to have.³

These are, of course, controversial topics, and the final chapter includes reform proposals that might invite controversy (and hopefully productive discussion). The primary effort, though, is not to reform the Fed, but to explain it, and in the process to provide hard thinking about the Fed’s governance, history, and authority in a way that, for example, would be useful to both former Fed chair Ben Bernanke and perennial Fed critic Ron Paul. Part of my optimism in the book’s ability to guide between these poles is that I step back from the notion that Fed independence is either a fragile public good that needs protection or a nefarious dodge of public accountability. In this book, Fed independence isn’t an object to be attacked or defended, but a set of relationships to explain. If I succeed, readers will not be able to take for granted invocations of “Fed independence,” in attack or defense, as the final word on any question.

A few words about the book’s methodological approach and its scope: While I draw extensively on published memoirs, annual reports, legislative history, and the historical record on the Fed generally, the book does not, after the first two chapters, tell a chronological story. Instead, I use scores of examples from Fed history in service of an analytical argument about the Fed’s governance, its external relationships, and the ways it makes national and international policy. To keep this kind of analytical approach engaging to specialists and generalists alike, I leave the text as free of jargon and intramural academic debates as possible. For those interested in these details, I add them in the notes. To enhance readability, I leave those notes at the end of the book and restrict them to one note per paragraph.⁴

The book is also far from exhaustive. It raises countless avenues left to explore in understanding the Fed’s place in government and the ways that insiders and outsiders alike influence its policies. The two main omissions are comparative: the framework developed here—a framework skeptical of “independence” as a valuable analytical tool for understanding policy making—touches only briefly on the details of central bank governance in other parts of the world, even less on similar questions for other kinds of governmental agencies in the United States or elsewhere. My hope is that the ideas here will generate useful insights for scholars who take on these other questions directly.

Finally, a word about the book’s epigraphs, all taken from the great Walter Bagehot. Bagehot—pronounced BADGE-it in American English, BADGE-ot in Britain, a shibboleth of sorts in central banking circles—is widely viewed as the intellectual godfather of modern central banking. Whether his world has much to say to ours is an open question, but there are few wordsmiths in financial history quite as able as he. He is the author of magnificent sentences, very interesting paragraphs, and sometimes frustratingly indeterminate books. But because of the power of those sentences, I borrow liberally from his iconic 1873 book, Lombard Street: A Description of the Money Market, for the epigraphs that introduce each chapter (except for chapter 4, which comes from his other famous book, The English Constitution). Bagehot obviously had nothing to say about the Federal Reserve System, which was founded decades after his death. And he barely had more to say about the U.S. financial system (he wasn’t very impressed with nineteenth-century U.S. finance). But his turns of phrases are too applicable and felicitous to pass by, even if the reader must change some of the proper nouns to make them relevant.