Why is the Federal Reserve Viewed as the Fourth Branch?

Peter Conti-Brown’s essay provides an excellent overview of the constitutional objections to the Federal Reserve and to the structure of the Federal Open Market Committee (FOMC). I want to approach the questions that he addresses from a slightly different angle, by asking why politicians and courts treat the Federal Reserve as if it were constitutionally untouchable.

There is obviously more than one way of thinking about whether something is constitutional. The most direct approach looks at whether a specific provision of the Constitution or a Supreme Court case guarantees a given right or power. Another method–that draws on the unwritten British Constitution–asks whether certain practices or institutions are now so ingrained in our political culture that it would be unthinkable to abolish or substantially change them. To take a simple example, nothing in the Constitution requires that the Supreme Court consist of nine Justices. Nevertheless, many people would denounce legislation that sought to expand the Court to fifteen Justices as unconstitutional. What would they mean by that? Presumably the answer is that they think that such a statute would damage important values regarding the separation of powers and the rule of law. Moreover, they would be making those arguments against the backdrop of a specific precedent—Franklin D. Roosevelt’s unsuccessful attempt to pack the Court in 1937—that casts a long shadow over any new effort to change the magic number of nine Justices.

The independence and makeup of the Federal Reserve falls into the second (and more informal) of these constitutional categories. As Conti-Brown points out, Congress created the FOMC in the 1930s. This was done because the original governing structure set up by the Federal Reserve Act of 1913 was viewed as a failure after the disaster of the Great Depression. At the time, though, there was no understanding that the Federal Reserve was supposed to be above politics. During the 1920s, Treasury Secretary Andrew Mellon played a major role in setting interest rates as a member of the Fed’s Board of Governors. The Banking Act of 1935 removed the Treasury Secretary from the Board, but that step towards institutional autonomy was largely a matter of form. During World War Two, the Federal Reserve entered into an agreement with the Treasury to finance military spending by keeping bond rates pegged at .0375%. When the war ended, the Treasury Secretary bullied the central bank into sticking with this agreement to stimulate the economy even though the FOMC wanted to tighten monetary policy. The nadir of the Federal Reserve’s authority came when the FOMC held one of its meetings with President Truman in his office, which would be unthinkable now and was a powerful symbol of the Fed’s subservience to the White House.

The independence of our central bank, like the independence of the federal judiciary, rests on a norm that took a long time to develop. One crucial event—the Federal Reserve’s Marbury v. Madison—was the 1951 Accord with the Treasury that dissolved the interest rate agreement reached a decade earlier and gave assurances that the Executive Branch would not interfere overtly with the FOMC. Exceptional leadership from Chairmen such as William McChesney Martin and Paul Volcker gradually made that paper guarantee into a reality. There was also a growing recognition around the world that central bank autonomy was important for containing inflation and for checking the power of politicians who would otherwise print money before elections to maximize their chances of staying in office. Almost no major democracies had an independent central bank in the 1930s, but today virtually all of them do.

To be sure, the Federal Reserve’s autonomy is secured by more than just the kindness of strangers. Unlike almost every other federal agency, the Fed can fund itself through earnings from bonds and other investments and therefore does not depend on congressional appropriations. Conti-Brown explains that members of the Board of Governors may be fired only for cause, and as far as I know no Fed Governor has ever been fired. Furthermore, Conti-Brown provides a terrific discussion of the status of the Federal Reserve Bank Presidents, who are private citizens chosen by other regional bankers and are virtually impossible for the President or Congress to remove. This odd arrangement was the result of a compromise in 1913 between supporters of a private central bank, modeled on the Bank of the United States created by Alexander Hamilton, and one that was entirely under public control.

While these structural guarantees count, the Federal Reserve’s freedom from political control is basically just a custom. Congress can alter the FOMC at any time with a simple statute, and the President could influence its members with promises of further patronage or favors. Any attempt to do either, however, would create a firestorm comparable to a bill that tried to make significant reforms to the federal courts or to presidential lobbying for a particular decision from the Supreme Court. In this sense, the claim that the central bank is too independent is not a constitutional argument at all, unless someone is making the far-fetched assertion that Congress may not delegate its authority over the money supply in the way that it has. Criticisms of the Federal Reserve should, as Conti-Brown says, be directed at its masters in Congress or at the President when a nomination is made to the Board of Governors.

The aura that surrounds the central bank helps explain why its unusual arrangement will not be challenged successfully in court. Conti-Brown is probably correct when he says that nobody has standing to attack the constitutionality of the way in which the private bankers on the FOMC can be removed. His conclusion in this respect, though, is not just a matter of doctrine. Even if a sound argument could be made for standing, the federal courts would probably be very reluctant to get involved in what Justice Felix Frankfurter might have called the “monetary thicket.” The same impulse would, if the courts did reach the merits, probably drive them to find a way to distinguish Free Enterprise Fund v. PCAOB and say that its reasoning does not apply to the FOMC. The Federal Reserve is unlike any other federal agency by dint of experience, and thus the central bank should not be treated like just another agency.

Political independence without transparency does raise some basic constitutional concerns, but Chairman Ben Bernanke will leave behind a much more open central bank. Secrecy was long seen as an integral part of being the lender of last resort. Until recent years, the FOMC observed a rule of strict confidentiality about its meetings and Wall Street had to sift through various clues to guess what decisions were taken. Today the minutes of these meetings are made public after a relatively short period of time, the Federal Reserve issues a statement explaining its actions after each significant meeting, and members of the FOMC often give their views through speeches, interviews, and (in the case of the Chairman) press conferences and congressional testimony.

The central bank can continue this march towards greater accountability through two simple reforms. First, the Federal Reserve could make the selection process for regional bank presidents more transparent by publishing a list of the finalists and then allowing for a notice-and-comment period that would give the public an opportunity to weigh in on who should receive the position. These are powerful officials who are not subject to the usual vetting by the President and the Senate, but scrutiny from the media would be better than nothing. Second, members of the FOMC who dissent from decisions taken by the majority do so today without opinion. They should instead be encouraged to offer a written explanation of their dissenting vote in response to the statement provided the majority, as this would make it easier to understand the implications of the decisions being taken.

One century after its birth, the Federal Reserve’s independence is still probationary. The FOMC relies on a reservoir of trust earned through many crises that shapes their relationship with Congress and with the Executive Branch. As a result of its successful stewardship, the informal constitutional authority of the central bank is greater that most of the formal authority found in the constitutional text.