True Manipulators of the Fed Are on Capitol Hill

When Fed-followers tell each other horror stories about political manipulation of the Federal Reserve, the most oft-told tale concerns President Richard Nixon. In the election year of 1972, Nixon hectored Federal Reserve Chairman Arthur Burns to flood the economy with money. More precisely, in that inimitable Nixonian style, the President told Burns that concerns about inflation were “just bullshit” and explained, “I don’t want to go out of town fast,” so the economy had better be in good shape by November.

Burns’s inflationary policy was widely noted at the time, giving rise to an entire study of “political business cycles” through which elections determined central bank policies. For decades at least, the Fed’s “myth of independence” has carried little more weight with scholars than the myth of George Washington and the cherry tree. When Nixon himself first appointed Burns, the President said, “I know there’s the myth of the autonomous Fed,” but told Burns to ignore it.[1]

Although Sarah Binder and Mark Spindel’s book The Myth of Independence: How Congress Governs the Federal Reserve does flog an already long-dead “myth,” it also makes a valuable addition to previous studies of political manipulation. While researchers have focused on presidential arm-twisting, the even more substantial powers that Congress wields over the Federal Reserve have receded into the scholarly background.

In reality, congressional influence over the Fed has always been preeminent. The authors quote William Proxmire (D-Wis.), the powerful Senate Banking Chair from the 1970s, who said, “I have long favored the independence of the Federal Reserve Board from the Executive Branch.” But Proxmire rooted this putative independence in another type of control. He went on to call the Fed “a creature of Congress . . . We can abolish it. We can modify it. It is our responsibility.”

In fact, in every Congress since World War II, legislators have introduced from one to 60 bills aiming to reshape the Fed. Many of these bills passed. In 18 of 103 years since the Fed’s creation, Congress enacted a major Federal Reserve reform. The Fed’s internal deliberations quoted in the book show that it takes notice of these. The Fed knows the number of such bills goes up when unemployment is high, or after the Fed raises interest rates, so it trims its sails accordingly.

Binder and Spindel demonstrate that even many Fed actions taken without direct congressional intervention were done under the shadow of Congress’ power. The Fed-Treasury Accord of 1951, which guaranteed the Fed’s independence from the U.S. Department of the Treasury, is often seen as the result of the Fed’s noble struggle against executive tyranny. In fact, at the time, Senator Paul Douglas (D-Ill.), backed by a unanimous congressional study panel, had introduced a bill to give the Fed complete control over monetary policy. Just days after the bill was introduced, the administration announced its accord, using almost identical language. It was the congressional push, not Fed obstreperousness, which gave the Fed “independence,” at least from the President.

Similarly, when Fed Chair Paul Volcker decided to fight inflation in 1979 by reducing the money supply and raising interest rates, he and others at the Fed noted that only the general political anger against inflation allowed them to do so. Many inside the Fed argued that without congressional support, they would have to retreat from their harsh anti-inflationary program, as they had done in the past.

The book shows, however, that the partisan complexion of attacks on the Fed has changed. Before the late 1970s, Democrats introduced most of the Federal Reserve reform bills, which usually aimed to force the Fed to pay less attention to inflation and more to unemployment. After 1977, when Congress passed an act establishing the Fed’s “dual mandate,” demanding it strive for both low unemployment and low inflation, the complexion shifted. Republicans introduced more bills reforming the Fed, usually to rein in its supposedly inflationary tendencies.

For instance, the original “Audit the Fed” bill was introduced by the Texas Democrat Wright Patman in the 1950s as part of his campaign to loosen the monetary spigots; today, the “Audit the Fed” movement tends to be associated with anti-Fed and anti-inflation hawks in the Republican Party, especially former Representative Ron Paul of Texas and his son, Senator Rand Paul of Kentucky. While the original Humphrey-Hawkins bill in 1977 demanded the Fed target a permanent 4 percent unemployment rate, today congressional activists demand the Fed adhere to a specific inflation rate.

Some of Binder and Spindel’s most important, albeit subtle, discoveries concern the geographical locations of the 12 Federal Reserve Banks. Previous writers have argued that these sites were chosen by an autonomous committee for purely economic reasons, without any political skullduggery involved. The authors show that at least five of the cities were chosen with politics in mind. Richmond, Atlanta, and Dallas, in particular, held very little bank capital and were ranked low on measures of commercial success. Yet each acquired its own Federal Reserve Bank. (When a Federal Reserve Bank was opened in Dallas in 1914, that city wasn’t even in the top 50 largest cities in the country.) The book argues that a Southern-dominated Democratic Party wanted to spread financial power to its home turf, and succeeded in doing so.

Although this geographical aspect may seem to be a mere historical oddity, Binder and Spindel show that it had long-term consequences. Unlike most other “central” banks, the Federal Reserve’s decentralized structure has created diverse and lasting constituencies for defending the system in Congress. Representatives from the 11 states with Federal Reserve Banks (Missouri has two) have time and again voted to protect the system against drastic reforms. When, in 1933, Congress proposed a bill to give the President the power to inflate the currency on his own, representatives from Reserve Bank states were more likely to vote against it. The next year, when Congress tried to impose a dual gold and silver standard, these same representatives helped knock that idea down.

Even in 2010, representatives in Reserve Bank cities were more likely to vote against an “Audit the Fed” measure. Although the Reserve Bank representatives didn’t win every battle, the countrywide network of support enjoyed by the Fed helps explain the continuities in its structure.

Of course, congressional interest in the Fed is at its zenith in the aftermath of any economic or  financial crisis. Binder and Spindel state at the outset that they hope to test “the main claims of the book: that crisis begets blame, and blame begets reform.” Without elaboration, such a statement seems so obvious as to hardly merit discussion. Yet, like their attack on the already dead Fed “myth,” this argument is more substantial than they at first let on. They show that after crises, Congress has consistently pointed its collective finger at the Federal Reserve and demanded it shoulder the blame. Yet each and every time, Congress has passed laws that “reformed” the Federal Reserve by making it even more powerful.

After World War I, the Great Depression, the stagflation of the 1970s, and the 2007-2009  financial crisis, Congress lambasted the Fed’s failures, and decried its idiocies—then immediately expanded its influence. Such reactions are the ultimate in buck-passing. Congress knows that the more power the Fed has, the more likely it can shoulder the blame for economic failure. After each crisis, however, Congress also has demanded more transparency, which now includes  recorded meetings, public statements of intentions, stated mandates, and so on. These measures are a small price to pay for such power, and the Fed has accepted them.

One could criticize the book in some regards. Its rendition of the most recent financial crisis is the usual canned history of deregulation run amok and greedy banks’ passing bad securities to unwitting customers. The book is clear-eyed, but occasionally obfuscates the obvious with talk of vague “models” and “theories.” It is almost wholly reliant on previous studies, except for a handful of independent regressions and a few new data collections. There are some minor historical errors. (The 1900 Gold Standard Act didn’t end the coinage of silver as an alternate monetary standard; this had stopped back in 1873. In 1932, Republicans didn’t control all of Congress, since Democrats controlled the House).

But these are only quibbles. The Myth of Independence offers even dedicated Fed-watchers fresh information and insights. It focuses the spotlight of political science on a subject that hitherto has not attracted much interest from that sector, and provides compelling evidence about how congressional clout has shaped this institution, which has risen to unrivaled global power and influence.

Today, with the vote of a handful of unelected officials, the Fed can buy trillions of dollars of assets from domestic and foreign sources, direct credit to certain sectors, raise or lower the interest received by banks on their deposits, dictate bank dividends, affect Treasury bond yields and stock markets, and shape the value of the world’s most important currency. Its political and economic power emerges from the broad discretion Congress has granted it. Congress has increased the Fed’s near unfettered ability to create money and direct it to certain sources, subject only to congressional badgering and the weak guideposts of following the lawmakers’  “dual mandate.” Inside those expansive boundaries, the Fed can act as it pleases.

If, however, Congress gave the Fed clearer guidelines—such as the goal of a specific inflation rate or price level, or a specific monetary policy rule to follow—it would be better able to keep the U.S. economy on an even keel even as its discretion would be limited. Such a move would indeed impinge on the Fed’s “independence,” but it would also tie its exercise of power to a definite responsibility. Binder and Spindel deny the necessity of further constraining the Fed. But their fine book implies that a more direct mandate might indeed be the next step in the evolution of the relationship between Congress and the Federal Reserve. If so, it would be a welcome step in that ongoing, and hitherto underappreciated, association.

[1] Burton Abrams, “How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes,” Journal of Economic Perspectives 20:4 (Fall 2016), 177-188.