“Fundamentally,” U.S. President Biden said as he nominated Jerome Powell for another four years as the world’s most powerful central banker, “we need stability and independence at the Federal Reserve.” He’s probably right about that.
The problem is that the need for stability — and for avoiding shocks for the markets and for independence — cuts across the desire to exert more democratic control over central banks. Far more powerful than it was ever designed to be, and critical in the fight against inflation, the Fed now transcends democratic control.
Powell’s decisions on inflation could decide the political fate of Biden and his party. And yet Powell’s inflation strategy seems to have been virtually irrelevant to Biden’s decision to re-nominate him. Not only that, but the only other candidate considered, Vice Chairwoman-designate Lael Brainard, has never failed to vote in line with Powell on monetary policy in the seven years they have served as Fed governors.
If there were any significant differences between their plans for the future (the market, very questionably, assumed that Brainard would be less aggressive about tightening policy and raising rates), these were never given a public airing. In any case, over the the past three years, Powell has been as activist and dovish as it’s possible to imagine. It’s doubtful that Biden was able to hear two contesting views and decide between them, and certain that neither the electorate nor the legislature got to do so.
To compound the sense of institutional capture, Biden judged the risk of ratcheting up uncertainty so great that the only candidates he considered had already spent many years at the institution. He judged that any attempt to bring in “fresh blood” would have been too risky, and would have left the Fed looking like a partisan body.
He’s probably right about this. But his judgment implies that the Fed is now so powerful that elected politicians cannot touch it. That is terrifying. It’s no surprise that the role of the Fed is one of many contemporary issues where the libertarian right and the populist left make common cause against the status quo.
The electorate gets to express, with its votes, an opinion on more or less every other aspect of economic policy — taxes, fiscal strategy, tariffs and the rest — but not on monetary policy. The chair of the Fed must be given freedom of action, but the key opportunity that comes once in each presidential term for elected politicians to set the direction of monetary policy has just come and gone, without any input from voters. That does seem hopelessly undemocratic.
There is a counterargument. What some might call a more “democratic” institution, others would describe as “politicized.” One of the most influential macroeconomists of his time, Rudiger Dornbusch of the Massachusetts Institute of Technology, went so far as to say in 1999 that “there is no such thing as a responsible politician, democratic money is bad money.” He was talking about the creation of the European Central Bank, but he reflected the importance that central bank independence had taken on.
Independent central banking is a relatively new phenomenon. In the years after the war, the Fed had to keep rates low to ease the burden of war debts. In the U.K., the Bank of England left crucial decisions on interest rates to the chancellor of the exchequer, an elected politician who also controlled fiscal policy until 1997.
But central banking independence has taken on overwhelming importance as it is now the de facto replacement for the gold standard. After Richard Nixon loosed the last remaining tie of the dollar to gold in 1971, inflation took off. It came under control again only after the Fed under Paul Volcker aggressively proved its independence, hiking rates in a way few democratic politicians would ever permit. Ironically, Jimmy Carter, who appointed Volcker, suffered a landslide defeat because voters had lost trust in him to control inflation.
Since then, independent central banks targeting inflation have taken the role previously held by gold. They are the anchor for the financial system, the guarantors of stability. Democratic crosscurrents would make it impossible for them to play this role.
This month, Turkey has shown just how bad democratic money can be. Under pressure from President Recep Tayyip Erdogan, the central bank has cut rates three times even as inflation shoots into double figures. This month alone, the Turkish currency has lost 16% compared to the dollar. Political meddling has created a crisis. Nobody wants the rest of the world to return to that.
But what central banks did last year goes far beyond acting as an anchor for the system. It thus grows harder to sustain giving Powell another four years without some much greater democratic process. As Columbia University’s Adam Tooze puts it in his recent book “Shutdown,” financial crises had converted central bankers from “ringmasters to ever more frantic jugglers of liquidity.”
As Tooze writes: “While the central banks remained the key actor in the drama, they were doing precisely those things the prohibition of which was central to founding central bank independence in the 1970s and 1980s.” It had always been taken as axiomatic that central banks could not monetize government deficits by simply buying government bonds. Such a practice is directly inflationary, and yet this is what they were doing. “The shift from a world in which central bank independence was founded on not buying government debt to one in which central banks around the world warehoused trillions of dollars in debt,” says Tooze, “was bewildering.”
Powell’s actions last year, mirrored by other central banks, showed that central banks had become the world’s key economic actors. They had freedom of action and didn’t have to wait for voters or legislators. That was already clear after the Lehman Brothers bankruptcy in 2008, when the initial vote in Congress not to go ahead with the Troubled Assets Relief Program caused a market crash. Eventually, the TARP would prove critical in restoring confidence in U.S. banks, but in the meantime the Fed had no alternative but to step into the vacuum left by the politicians. In 2012, European politicians failed to clear up a sovereign debt crisis driven by bad fiscal policy decisions at the national level, and it was left to Mario Draghi of the ECB to resolve the situation by promising to do “whatever it takes.”
In all these cases, central bankers took critical decisions on the issues of wealth distribution and inequality. The market rally that the Fed spurred last year has been spectacular; it’s also been profoundly unequal.
It’s easy, but unfair, to describe this as a “power grab.” Central bankers themselves worry that they do not have the democratic authority to play their current role. Sir Paul Tucker, former deputy governor of the Bank of England, said: “This is partly our elected legislators sitting back, leaving central banks with little choice but to reinvent themselves as the U.S. cavalry.”
With polarized and gridlocked political systems across the western world and coherent fiscal policy lacking, central banks were the only players left standing. The problem is that politicians could delegate power to them, but not legitimacy. “They can earn legitimacy by how well they do their task,” Tucker said, “but then what’s their task? Voting them out is precisely what you cannot do with me and my tribe. So we need to be very careful about what we delegate to these bodies insulated from day-to-day politics.”
Central bankers now get the same kind of personal pressure and vilification that elected politicians get — Christine Lagarde of the ECB, for one, was lambasted this month as “Madame Inflation” in a German tabloid, in a piece that went through her wardrobe and accessories.
Central bankers could survive without democratic legitimacy when they were technicians overseeing a currency convertible into gold. As the principal drivers of the economy, their lack of legitimacy is more costly.
In his book “Unelected Power,” an ambitious attempt to deal with these problems, Tucker suggested setting up a system in which the president and Congress could give the Fed clear and ranked objectives. This would have been a huge task and might well be impossible in today’s polarized environment. But with clear priorities on issues like inflation and equality, central bankers would much more clearly have been stewards of the common good. This might have restored trust in an institution that, according to the latest consumer survey by the University of Michigan, is fast losing it.
Momentous decisions lie ahead for Powell and his colleagues before there will be another chance to fix the Fed’s democratic deficit.
John Authers is a senior Bloomberg editor for markets.
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