Regional President Speech

The Fed in a Political W o rld * By David P. East burn, President Federal Reserve Bank of Philadelphia Anyone following the banking press at all There is a strong political overtone to each of closely will notice questions like these these questions. Yet, it is frequently said that appearing frequently: the Fed is nonpolitical. Which is it? Are we political, or aren’t we? A simple “yes” or “no” • Whether the Fed in the eyes of Congress is answer, I’m afraid, is just that—too simple. A putting enough money into theeconomy to more realistic way to phrase the question is: assure recovery. how political is the Fed and in what sense? • Whether it is proper for a Federal Reserve In a broad sense the Fed must be part of the Bank to spend nearly $80 for cigars. political process. Politics is the art of •Whether the Fed should be audited by the government—in our system, representative General Accounting Office. government. Government must do what the people want; politics is the process of dis­ •Whether appointments of Federal Reserve covering what they want and how to get it for Bank Presidents should be confirmed by the them. Senate. Accordingly, the Fed must be responsive to •Whether the Fed will push up the money the public. To say that it is nonpolitical—at supply in order to help reelect President least in this broad sense—implies that the Fed Ford in 1976 as some people allege it did for knows better than the people themselves President Nixon in 1972. what they should have. This is an elitist view inconsistent with our form of government. Yet, there is something special about the . *A lecture delivered at the Graduate School of Bank- Federal Reserve. It manages the money sup­ 'ng. University of Wisconsin, Madison, August 11, 1975. ply. A lesson in history is that sovereigns fre­ The views expressed are mine and do not necessarily quently have abused their power to manage '•fleet those of my colleagues in the Federal Reserve System. money. Some years ago we published an 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis BUSINESS REVIEW OCTOBER 1975 analysis of this history which pointed out how liberals tend to advocate full employment Henry VIII at one time became known as Old policies, conservatives a stable dollar. The Copper Nose.1 The reason was that once he emphasis given to these objectives shifts over needed money and called in all the silver time. Last year public opinion polls indicated coins, and melted and recoined them with a that inflation was the number one problem. copper base. As the new coins became worn Now it is unemployment. The Fed finds itself and blotched, the most prominent part of constantly in the middle, trying to reconcile Henry's features, his nose, protruded through these two views. For example, in recent Con­ the thin silver coating in a dull relief of gressional hearings some experts argued for copper—hence, Old Copper Nose. Even our increasing money at the rate of 10 percent a own George Washington was saddled with year in order to reduce unemployment. the problem of paying his troops with paper Others argued that money growth should be money that declined so precipitously in value kept considerably below this rate because of that the Continental dollar cost more to print the fear of resumption of double-digit infla­ than it was worth as money. tion. Given this long history of abuse, the The official Fed position is that unemploy­ founders of the Federal Reserve System had ment is the short-run problem, and that we good reason for insulating the Fed from should try to facilitate recovery and bring narrow political pressures. The Fed is non­ down unemployment. Inflation, though, is political in this sense. Its fortunes are not tied the long-run problem and we must be careful to the reelection of any Government official. not to rekindle it. Overstimulating the It is for this reason that any official in the Fed economy now to achieve greater success on properly resents allegations that policy has at the unemployment front is likely to produce any time been slanted to influence elections. another round of double-digit inflation later. Having either observed or participated in The Fed must keep an eye on both the short meetings of the Open Market Committee for and long run when making policy. I agree a decade and a half, I can recall not a single in­ with this position but would feel better about stance when this motivation was present it if there were stronger Government either explicitly or implicitly. programs to deal with unemployment by There is constant tension between these other means. These include liberalized un­ two concepts—being responsive to the public employment compensation and more in the broad sense and being insulated from vigorous commitments to public service jobs, narrow, short-run politics. This tension more effective training, and a more enter­ characterizes much of what happens in the prising minimum-income program. Fed. It is seen in what we do and how we do it. The pushing and pulling between the ob­ jectives of stable prices and full employment, whatever the outcome today, will be a WHAT THE FED DOES political struggle which will be with us for,a long time. It involves value judgments on This is the biggest political issue because it is which people have strong differences. the most fundamental. It has to do with the kind of economy the people want. Let me make a generalization that is oversimplified HOW THE FED DOES IT but nevertheless says a lot about the environ­ Dispersion of Power through Organization. ment in which the Fed operates: political Political considerations strongly influence the ways in which the Fed goes about ac­ complishing its objectives. They are reflected ’“Henry VIII Revisited: The Problems and Temptations of Money Creation,” Business Review of the Federal first of all in its organization. The Federal Reserve Bank of Philadelphia, January 1960, pp. 3-18. Reserve Act was very much the result of a 4 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF PHILADELPHIA political process and the founders of the process provides an internal balance to this System had political considerations in mind power. Although it is inevitable that power when they hammered out the organizational relationships will change in this kind of an ad­ framework. ministrative situation, the "dispersion princi­ Internally, the organization emphasizes ple" is so fundamental to the Fed and the dispersion of power. In this sense, the national interest that power shifts over time organization of the Fed parallels that of should be back and forth rather than in one government. Heading the System is the Board direction—offsetting instead of reinforcing. of Governors—seven Governors, not one as Externally, the organization provides in­ in most other central banks—appointed by sulation from certain kinds of political the President and confirmed by the Senate. As pressure. The 14-year terms of the Governors a further dispersion of power, the Fed has 12 are designed to protect them against short­ semi-autonomous Banks. Each Bank has a term swings of partisan politics. This arrange­ Board of nine Directors. Three come from ment enables the Governors to give ap­ banking, three from the ranks of borrowers, propriate weight to the long-run conse­ and three (those appointed by the Board of quences of policy decisions. Without these Governors) from the public at large. The long terms, Governors would be subjected to Federal Open Market Committee (which has political pressures to achieve short-run the major responsibility for monetary policy changes in the economy, possibly at the ex­ formation) is a combination of the Board of pense of what is best for the economy over Governors and Presidents of Federal Reserve the long haul. Banks. The Federal Advisory Council is a In my view-, this complex organization group of bankers which advises the Board of provides adequate insulation against political Governors. This is a complicated mixture of pressures. However, some minor different groups designed to avoid concen­ modifications could be made. First, as has tration of power in one person or place. been proposed by several commissions in the Authority over policy tools is also dis­ past, the term of the Chairman of the Board of tributed. The Board of Governors determines Governors could be made to coincide with reserve requirements and sets many that of the President of the United States. Sec­ regulations, such as Regulation Q and margin ond, shorter terms for Governors, say ten requirements. Open Market operations are years, could be provided without much risk. governed by the Federal Open Market Com­ Third, a couple of the provisions which mittee. The discount rate is set by each Board Senator Proxmire has indicated he will in­ of Directors subject to review and deter­ troduce in a bill to reform the Fed could be mination by the Board of Governors.2 accepted without causing any harm.3 One of In all these arrangements the Board of these would have the Chairman's term sub­ Governors has most of the power and this is as ject to approval of the Senate. This would it should be, but the decentralized nature of enable Congress to have somewhat more the organization and the decision-making control over general monetary policy. A sec­ ond would require that consideration be given to candidates from consumer and labor 2Reserve requirements set the amount of reserves that groups when making appointments to the member banks are to hold. Regulation Q places a ceiling on all interest rates paid by member banks on time and savings deposits. Margin requirements set the cash down Payment required when purchasing stock on credit. Open Market operations—the buying and selling of 3U.S., Congress, Senate, Housing and Urban Affairs securities by the Fed—affect bank reserves, interest rates, Committee, S. 2285: A Bill to Amend the Federal Reserve and the growth of the money supply. The discount rate is Act to Provide for Senate Confirmation of Certain Ap­ the interest rate which the Fed charges member commer­ pointments, and for Other Purposes, 94th Cong., 1st sess., cial banks that borrow from it. 3 September 1975. 5 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis BUSINESS REVIEW OCTOBER 1975 Board of Governors. I don't believe this is economy works best with least detailed in­ necessary since members of the Board con­ tervention. The economy does need overall sider it their responsibility to look out for the regulation in the sense that, as Walter concerns of these groups among others. Bagehot4 said, money will not manage itself. Moreover, it would be undesirable to begin But the Fed has considered its job simply to be constituting the Board with members who one of regulating the overall supply of money view themselves as advocates of special in­ and credit and leaving it to the market to terest groups. Nevertheless, I see little harm in allocate that credit. However, there are those giving “due regard" to individuals from con­ who believe that the market doesn't do the sumer and labor interests in considering ap­ job well. It allocates credit in a manner that is pointments. incompatible with their view of social I do see positive harm, however, in the priorities. For example, during periods of other proposals Senator Proxmire has made. tight money the market allocates credit in a Most of all, it would be highly undesirable to way that severely affects housing and small have Congress make appropriations for business. Yet, many individuals rank these Federal Reserve expenditures. This would in­ sectors of the economy high on their lists of volve Congress in details of Fed policy and social priorities and seek methods of operations which, as I'll indicate shortly, Con­ shielding them when credit is tight. gress should not and cannot effectively un­ This is a matter that greatly concerns many dertake. I would also oppose having ap­ people and it is not going to go away. It is also pointments of Presidents of Reserve Banks one for which I happen to have a good deal of subject to Senate confirmation. On the sur­ sympathy. Undoubtedly, one approach is to face this appears to strengthen the hands of do what we can to improve financial markets. the Presidents in serving on the Open Market Ceilings on interest rates, for example, limit Committee, but it promises to politicize their the free flow of funds, often to the detriment appointments, to undermine the role of the of “high priority" sectors of the economy. local Board of Directors, and to open up a The Hunt Commission (President's Commis­ number of undesirable issues with regard to sion on Financial Structure and Regulation) employment status and compensation. Final­ tried to get to the heart of this problem by its ly, the provision to provide staff assistance for recommendations for sweeping changes individual Governors is a detail which can be among financial intermediaries. Improving handled best by internal administrative markets is all to the good, but it is likely to arrangement. happen slowly and with difficulty. Another approach is for the Federal Government to in­ tervene in markets through fiscal action. In Fed Philosophy: Free Markets versus Credit recent years, the formation of a number of Allocation and Fine Tuning. A second way in Government mortgage agencies has been which political considerations influence how effective in helping the housing sector. Such the Fed does its job is in the philosophy of actions are a more direct method of providing operation. Let me make another generaliza­ funds. The problem with them is that Govern­ tion that is somewhat oversimplified but ment may become involved in credit markets nevertheless goes far to explain many con­ to a greater extent than desired. flicts: the Fed tends to emphasize the free market; many politicians tend to emphasize intervention in the free market and fine 4This nineteenth-century English economist, political tuning. analyst, and editor, was a practically trained theorist on This difference is seen first of all in the banking and financial matters. His Lombard Street (1873), written to explain the necessity of keeping a greater allocation of credit. In emphasizing the free reserve in the hands of the Bank of England, helped for­ market the Fed traditionally argues that the mulate the modern theory of central banking. 6 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF PHILADELPHIA Finally, this leaves us with selective credit stress on very short-run movements in the controls.5 This is a possibility that has always money supply. Financial houses, for example, had a great deal of appeal to me. Unfor­ put out letters which make mountainous in­ tunately, there is a real question as to whether terpretations out of molehill changes in the such controls work. Representative Reuss's money supply. proposal to place differential reserve re­ Most of us in the Fed take an eclectic view quirements on different kinds of assets, for of the money supply and interest rates. Both example, is an intriguing possibility. Our are important. On finetuning, we believe that analysis of this, however, raises practical money growth should not be constant but problems. If the Fed were to try to encourage know from experience that it cannot be con­ banks to make mortgage loans by putting a trolled precisely. At the same time, to be low reserve requirement against them and honest, there is often in the Fed a tendency to discourage banks from making business loans pay undue attention to small fluctuations in by putting a high reserve requirement against interest rates. Hopefully, we're getting over them, other lenders would more likely begin that syndrome. to fill the gap left by commercial banks. If con­ I hope also we can avoid the syndrome of trols were applied to these other lenders, the fine tuning the money supply, but it isclear to open market could move in to close the gap. me that as attention paid to the money supply We could find ourselves in a costly strait has grown there has been a tendency to ex­ jacket of credit controls. pect too much precision in controlling it. I In my view, no one has the answer to the believe we should try to smooth out extreme question of credit allocation. I'm certain only movements without yielding to the tempta­ of one thing: the Fed cannot afford to ignore tion of trying to eliminate all unwanted it and despite practical and philosophical movements in money. To do even this much problems should continue to study all smoothing of the money supply will mean we possibilities. will have to permit more flexibility in money- In addition to those focusing on the alloca­ market rates. tion of credit, there are others who advocate There are a few modifications that would be fine tuning the money supply and interest helpful in this regard. The first has to do with rates. We are, of course, familiar with the making information about monetary policy longstanding dispute between the decisions more readily available. The Fed now monetarists and the fiscalists with respect to announces its Open Market decision 45 days fine tuning the economy. What's not always after the fact. This departure from secrecy has appreciated, however, is that both schools done much to dispel the belief that financial nave their fine tuners. markets would be unduly disturbed or that Traditional monetarists are mostly anti-fine large financial firms would gain an unfair ad­ tuning. They argue that if the Fed tries to vary vantage in money markets. In my view, the the rate of growth of money it will do more next step is to move to a 30-day delayed an­ narm than good. Consequently, it should nouncement. If this action has no damaging simply aim for constant growth of money impact, the immediate announcement of regardless of what happens to interest rates. A policy decisions should be considered. More new breed of monetarist—one who pores information of this nature would promote over weekly money supply figures in great better understanding of the Fed and its deci­ detail—has been developing. He puts great sion-making process. The second modification has to do with im­ proving money-stock control by the Fed ’Two bills currently pending in Congress would have Member banks have been leaving the System y>e Fed direct some form of selective credit controls: primarily because they must forego earnings ^•887 sponsored by Senator Richard S. Schweiker and 212 sponsored by Representative Henry S. Reuss. on the reserves they are required to hold 7 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis USINESS REVIEW OCTOBER 1975 /hile their nonmember counterparts often the Executive branch is a very delicate re permitted to earn interest on a portion of arrangement. Obviously, monetary policy heir reserves. Declining membership means cannot go completely off on its own without smaller portion of the nation's stock of some coordination with the Government’s loney is directly influenced by the Fed. To economic organization. Much consultation ive the Fed greater control over the money and coordination goes on—say 99.99 percent upply, I support legislation that would es- of the time. The important thing is to preserve ablish uniform reserve requirements for all a degree of independence needed for that .01 ommercial banks. An alternative that would percent of the time—that rare and extreme Iso resolve the problem is Congressional ac- situation in which the Fed disagrees fun­ ion to permit the Fed to pay interest on damentally with the President. This is the riember bank reserves. While either change meaning of “independence.” /ould not be a cure-all, it would enhance the A special case in the Fed’s relationship with ed’s chances of achieving its monetary policy the Executive branch has to do with Treasury oals. financing. The Federal Reserve System has a In sum, it is clear to me that all this pressure great responsibility to see that a new issue of Dr fine tuning and improved credit allocation the Treasury does not fail. At stake is the eflects something basic in our society—the credibility of the Government’s credit. There ising standards expected of public officials. It is a danger, of course, in going too far in this eflects the fact that people are not content to direction as we learned during and im­ /atch the market exert what they consider mediately after World War II. At that time, the dverse effects on sectors they are concerned Fed supported prices of Government bout. It reflects increasing pressure for in- securities to the point where it had become ervention in markets and demand for greater “an engine of inflation.” This problem was >recision in controlling them. But it is also solved in 1951 when the Fed and the Treasury lear that the state of the art is not up to these reached an Accord by which the Fed gave up lemands and that this conflict between rising its support of the Government securities expectations and limitations of performance market. In return the Fed ever since has pur­ /ill continue to be a source of political dis- sued an “even keel” policy during periods of >ute. As the conflict continues, I believe the Treasury financing. This policy in effect ed should stand by its free-market pledges the Fed to a position of neutrality (hilosophy but it cannot ignore these while the Treasury is raising money. tressures or take an extreme laissez-faire In times when the Treasury is almost con­ iew in dealing with them. stantly in the market, even keel could serious­ Intragovernmental Relations: A Delicate ly erode the Fed's flexibility in changing ialance. A third way in which political con- policy. However, in recent years, particularly iderations are reflected in how we do our job as the Treasury has evolved new methods of i in the relation to the Executive and financing, even keel has gradually been get­ egislative branches of Government. The Fed ting more flexible. This is no longer a critical eports to Congress, not to the President. The problem in the relationship between the Fed eason for this is the history of the abuse of and the Executive. loney by the Executive. The Secretary of the A more difficult question currently has to reasury was once an ex-officio member of do with the Fed’s relationship with the ie Federal Reserve Board. He was removed Legislative branch. The Federal Reserve is a ecause he has to borrow money to pay the creature of Congress. Congress can take any ills and might have a tendency to want the action it wishes with respect to the Fed, in­ Dwest possible interest rates. cluding abolishing it. The immediate question Yet, the relationship between the Fed and is how much should Congress be involved in 8 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis FEDERAL RESERVE BANK OF PHILADELPHIA the details of monetary policy. The Constitu­ billions of dollars of assets are all there. As has tion gives Congress the power to coin money been pointed out many times, however, the and to regulate the value thereof. But this danger in the proposal is GAO involvement in leaves open the question of how much monetary policy. The Fed already reports all authority it should retain and how much it policy actions to Congress and the concurrent should delegate to the Fed. I believe it is clear resolution further strengthens that reporting that Congress should retain general oversight relationship. The GAO is not well-equipped but should allow the Fed enough room to to interpose itself between the Fed and Con­ make unpopular decisions in the short run gress on the matter of monetary policy. thatwill prove wise in the long run. Also, Con­ gress should not involve itself in the details of CONCLUSIONS monetary policy. For one reason, Congress Politics is an art. Central banking is an art. can be just as susceptible to temporary This means that there are no absolutes and political pressure as the President. For that political influences are constantly fluid. another, Congress lacks the necessary exper­ For example, recently the emphasis on con­ tise in monetary policy formation and in its sumerism has involved the Fed in Truth in implementation to be calling the day-to-day Lending, Fair Credit Billing, and Equal Oppor­ or even month-to-month monetary signals. tunity in Credit. This additional responsibility Earlier this year both houses passed a promises to involve the Fed even further in resolution which provided for more direct political considerations. An irony of thisisthat control over monetary policy.6 This was a the Fed tends to get these jobs because it is proper step and promises to help focus policy regarded as nonpolitical. on longer-run objectives. It remains to be Thus, pressures toward greater political in­ seen, however, if Congress uses the tool volvement for the Fed are increasing. effectively. As the Fed and Congress proceed Awareness on the part of the public of the Fed to feel their way under the concurrent resolu­ is greater than ever. Opinions about what the tion, a great deal of cooperation and good Fed should do are more pronounced than faith will be necessary on both sides. ever. Pressures on Federal Reserve officials to A final aspect of Fed-Congressional perform better are greater than ever. De­ relationships has to do with the proposal to mand for information about what they are do­ have the General Accounting Office audit the ing is stronger than ever. If there were times Federal Reserve System. I can speak from per­ when officials could sit in their marble halls sonal experience that the Fed is thoroughly and mysteriously pull strings that affect the audited now. I can understand that in a post- economy without anyone questioning their Watergate environment there would be a actions, those times are gone. We must be in­ desire to provide for the assurance that the creasingly open, responsive, and flexible. The challenge will be to accomplish this and yet 6U.S., Congress, Senate, Referring to the Conduct of be as firm and far-seeing as necessary to do Monetary Policy: Report to Accompany H. Con. Res. 133, our job of securing a healthy economy. ^4th Cong., 1st sess., 17 March 1975. 9 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

David P. Eastburn (1975, August 10). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19750811_david_p_eastburn

@misc{wtfs_regional_speeche_19750811_david_p_eastburn,
  author = {David P. Eastburn},
  title = {Regional President Speech},
  year = {1975},
  month = {Aug},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19750811_david_p_eastburn},
  note = {Retrieved via When the Fed Speaks corpus}
}