Since the creation of Federal Reserve, the value of the dollar has fallen by more than 90 percent, and that is not a surprise.
The idea of a mixed regime goes back to ancient times. Philosophers contrasted pure regimes, like democracy or oligarchy, with those that combined different classes, such as the aristocracy and the plebes, in different roles. These latter regimes were generally thought to create a more balanced and stable social order.
While the United States might appear to be a purely democratic or republican regime, the very substantial power wielded by the Supreme Court and the Federal Reserve makes our regime effectively mixed. The Court makes major decisions interpreting the United States Constitution. The Fed sets short term interest rates, regulates credit—the lifeblood of the economy—and acts as lender of last resort in financial crisis. Both institutions are insulated from democratic control and heavily influenced by elites.
The aristocracy of today that shapes the output of these institutions is not the aristocracy of old that depended on land. Our aristocracy is the cognitive elite, those that by dint of their intellect and education occupy the commanding heights of our society and economy. And this elite is divided roughly into two groups: those who are good at manipulating words and those are good at manipulating numbers. These talents correspond to law and finance respectively and thus to the Supreme Court and the Federal Reserve.
While the Federal Reserve has been called by journalists the Supreme Court of Finance, the Court and the Fed have not often been compared despite their essential similarities. It is not only that they play similar sociological roles, but that both also enjoy legal independence from control of the political branches. While that independence is formally different, it has strong functional similarities because it is ultimately protected by the power of their elites that surround them.
But because of this independence, the discretionary power that each institution wields also creates similar dilemmas in a nation whose principles appear on the surface to be more purely republican. Most of the time, both institutions appear to be engaged in the conventional norms of their elite craft. The Court spends a lot of time quoting its own precedents to justify judicial outcomes and the Federal Reserve talks about various economic factors in setting out its decisions to cut interest rates. But that form of reasoning often just hides the discretion. Supreme Court opinions are often notorious for slaloming through precedents to reach the desired result. The economic factors the Federal Reserve cites could provide the basis of many different decisions.
In both cases, partly because of discomfort with this discretion there is a periodic movement toward binding each institution with rules. Originalism in constitutional law and the Taylor Rule, which gives guidelines for adjusting interest rates, for instance, come from different intellectual spheres yet both share an impulse to limit elite power.
Today’s polarization of elites may raise serious questions about the beneficence of each institution. One of the virtues of a mixed regime is that its aristocratic element may be regarded as a stabilizing influence, because it is interested in securing its long-term position. And for the good of society it is essential to have stable money and a stable rule of law. But if elites become polarized, we may have a Court riven between originalism and living constitutionalism and a Fed divided between some form of monetarism and new more left-wing ideas like modern monetary theory.
Given the centrality of these institutions to the United States, I will devote three essays to comparing them. In this first essay, I describe the similarities in their functions in a market oriented democracy and in the theories about why they enjoy institutional independence.
Modern Capitalism’s Demand for a Stable Rule of Law and Currency
Most modern capitalist societies have both independent central banks and independent constitutional courts—and have them for similar reasons. A stable currency and a stable rule of law are both essential to prosperity, allowing citizens to invest and plan for the future. While it might seem that the modern post-New Deal Court is largely focused on questions of civil, as opposed to economic, rights, that is not the case. Many statutes concern economic rights, and the Takings Clause and Contract Clause remain litigated constitutional provisions. Moreover, the structure of the Constitution—both the separation of powers and federalism—promote prosperity as well. Bicameralism and presentment slow down federal legislation, allowing for planning. Federalism permits jurisdictional competition among the states and that competition promotes prosperity. And even civil rights are crucial to prosperity: The First Amendment, for instance, permits citizens to bring to attention the shortcomings of incumbents. These structures are preserved in theory by independent courts exercising judicial review.
And just as a jurisprudence of rights protects prosperity, a stable money helps protect against oppression. To see how unstable money upends the social and civic order one need look no farther than Weimar Germany or contemporary Venezuela. In both cases the failure of currency put civil society under substantial pressure and undermined democracy itself. Moreover, hyperinflation makes it no less impossible to plan than laws whose interpretation is changed at the whim of the government. Hence the case for the independence of central banks. Both judicial review and independent banks can be understood as “auxiliary precautions”—in the words of Federalist 51—that avoid over-reliance on popular wisdom.
The Need for Precommitment: Ulysses and the Sirens
It is thus not surprising that commentators sometimes use exactly the same analogies to justify the independence of the Court and the Fed. Jon Elster argued that a constitution was needed to prevent the people in a populist moment from destroying the prudent constraints on their own power. Thus, he recalled the famous incident from the Odyssey where Ulysses orders his men to tie him down so he will not throw himself into the ocean at the invitation of the sirens’ beguiling songs. And if the constitutional framework is to be protected from buckling under the heat of ordinary politics, the Court must be independent of the people. As Justice David Brewer once said, his job was to protect “Peter drunk from Peter sober.”
Similarly, the Ulysses metaphor has been applied to the Federal Reserve. If politicians set interest rates, they might stoke economic growth to win popularity and reelection. But in the medium and long run, few profit from rampant inflation. The classic response has been to make central banks independent of politicians in an attempt to avoid what economists call the time inconsistency of popular preferences. People may want inflationary boom because it makes them feel good now, not least because it will reduce their debts, but it will likely lead to an unpleasant bust in the future. Again, the metaphor of drunkenness is used to dramatize the problem. Former Federal Reserve Chairman William Martin said it was his job to take the punch bowl away before the party got going.
In his excellent book on the Federal Reserve, Peter Conti-Brown has challenged the full applicability of this analogy with respect to the Fed. He notes correctly that sometimes the politicians and public call for the punch bowl to be taken away, fearing higher inflation. That observation is true but doesn’t much diminish the justification for the Fed’s independence, as a comparison with the Supreme Court shows. Once determined that the public may trample on rights that need independent protection, it is not much of an argument against judicial independence that the public may sometimes want these provisions enforced. The Court will need to interpret the same provisions, whatever the public’s unpredictable moods, and try to accurately reflect the constitutional framework that is the long term public interest. Similarly, the Federal Reserve will have to set interest rates, and one cannot predict in advance whether the public will be trying to undermine or to advance the public interest.
Moreover, public choice undermines the simple story that it is only passionate majorities that may distort public interest decision-making. Sometimes concentrated minority interests may be powerful in the democratic political process. Thus, over-enforcement of rights and over-tightening of the money supply can also be the result of political pressure from powerful minorities. For instance, the Tea Party in part reflected the power of older voters who wanted to preserve their fixed income savings against the risk of inflation. Without Fed independence their influence might have resulted in excessive monetary tightening, exacerbating the great Recession.
But if independence is justified, what are the mechanisms employed to achieve it? That is the subject of the next essay.