Professor Dorf and I have co-authored a new article, which is now available for download on SSRN and which we hope will soon be coming to a law review near you. (Hello, articles selection editors!) The article's title is "Don't End or Audit the Fed: Central Bank Independence in an Age of Austerity." Among other intellectual treats, readers of the paper will learn what a "spandrel" is.
Here, I will describe our motivations for writing the paper, as well as a few of its major points. But first, here is the abstract:
The Federal Reserve (“Fed”) is the central bank of the United States. Because of its power and importance in guiding the economy, the Fed’s independence from direct political influence has made it a target of ideologically motivated attacks throughout its history, with an especially aggressive round of attacks coming in the wake of the 2008 financial crisis and ongoing today. We defend Fed independence. We point to the Fed’s exemplary performance during and after the 2008 crisis, and we offer the example of a potential future crisis in which Congress fails to increase the debt ceiling to show how the Fed’s independence makes it the only entity that can minimize the damage during crises (both market-driven and policy-induced). We further argue that the Fed’s independence is justified to prevent self-dealing by politicians, even when no crisis is imminent. Although the classic justification for Fed independence focuses on the risk that political actors will keep interest rates lower than appropriate for the long-term health of the economy, we show that Fed independence addresses the risk of self-dealing and other pathologies even when, as now, political actors favor tighter monetary policy than appropriate for the long-term health of the economy.I have argued frequently that the "both extremes are equally crazy" view of American politics -- in which both the liberal and conservative parties are assumed to include equally reasonable centrists who disagree on matters of degree, while both parties are also thought to include equally unreasonable extremists -- simply does not describe the U.S. in the 21st Century, if indeed it ever did. For example, in my Verdict column and especially in my accompanying Dorf on Law post last Thursday, I contrasted the extremism of the supposedly mainstream Republican presidential candidates with the surprisingly non-extreme content of Bernie Sanders's "Democratic Socialist" views.
Whether one agrees or disagrees with me about any of that, there is definitely one policy area in which a politically important part of the left and a politically important part of the right are both dangerously extreme. (I say "politically important" to rule out the common move in faux-balanced reporting that draws false equivalence between something that, say, the hyper-conservative Speaker of the House might say and a nutty comment from some random kid at a Sanders rally.) That area of shared worrisome extremism is monetary policy. Interestingly, the too-extreme policy change favored by both the far left and the far right is the same: "End the Fed." Although the "audit the Fed" move is intended to sound less extreme, it is in fact the proverbial wolf in sheep's clothing. Either way, the idea is to attack the policy independence and political insulation that characterizes the modern central bank. We think that it would be a catastrophic error to compromise the Fed's independence.
We frame the paper by noting the possibility that events have overtaken the justification for independent central banks. The standard argument, after all, has always been that elected politicians cannot be trusted with the levers of monetary policy because of an inherent bias toward ruinously expansionary policies. Governments are elected and maintain their popularity, according to this view, by making promises to the hoi polloi, who just want "stuff." (Note that this is the view that Mitt Romney adopted to explain his loss in the 2012 election: Obama just gave voters "gifts" to get reelected.) And when it turns out that there is not enough money in the state treasury to pay for all that stuff, politicians will give into temptation and use the printing press to cover the bills, setting in motion hyperinflation. Fill in your favorite historical example here.
As the subtitle to our article suggests, however, this justification for Fed independence might no longer have any real-world significance. The political atmosphere in the U.S. and (even more) in Europe and the U.K. has been ruinously parsimonious since 2008, with politicians insistently refusing even to be responsibly responsive to the state of the economy. There has certainly been no support on either the left or the right to spend, spend, spend, and spend some more. If we live in an age when "austerians" rule the roost, why do we still need an independent Fed?
We respond to that question in several ways. The response that is most true to the original concern is that political winds can blow in many directions, and we maintain vigilance not just when times are bad but when times are good. (Let us set aside the point that there is nothing "good" about austerity in the current environment. We simply mean that ruinous austerity does have the silver lining of making hyperinflation nearly impossible.) Turning the Fed into a political institution that is controlled by elected officials would be a huge mistake, in our view, at the very least because it would be nearly impossible to return to an independent central bank during a precipitous turn away from austerity.
We further point out that the Fed's degree of independence, which is obviously not absolute, is necessary to prevent politicians from using monetary policy to influence election results. In contrast to other quasi-independent agencies that are nonetheless housed within the Executive branch, the Fed's policy levers are especially amenable to short-term manipulation. As important as the decisions made by, say, the EPA might be, those decisions will almost certainly not affect the economy in a predictable way that could advantage the "ins" and disadvantage the "outs" in the next election. We note that, even in an age of austerity, it is possible to use monetary policy negatively to harm the election prospects of some of the "ins," especially during a period of divided government.
We also observe that the people who are truly worried about "big government" should be especially enthusiastic about the importance of independent monetary policy. Because cuts in federal spending tend to increase unemployment (both directly and due to multiplier effects), liberals like me will often resist cuts to government spending by noting that such cuts will harm the economy. The standard response from orthodox anti-government types is, "Don't worry, the Fed will offset any contractionary impact of these cuts." That response is inoperative during a prolonged period of slack, because interest rates are already as low as they can go, but in something resembling more normal times, the existence of an independent Fed that can credibly promise to maintain something like full employment in the face of reduced government spending removes one argument that people like me might otherwise rely on. Arguments for and against spending cuts must be made on their direct merits, not their indirect effects. As much as I might otherwise like to have more arrows in my quiver, this is as it should be.
Regular readers of Dorf on Law will have noted in the abstract above that, to the surprise of no one, we tie our analysis back into the debate over the federal debt ceiling. Indeed, it is the Fed's possible role during a debt ceiling crisis that motivated much of our initial thinking about the importance of the Fed's independence. Having an independent Fed will be essential if the Republicans ever follow through on their threats to refuse to increase the debt ceiling, because only the Fed will be able to respond quickly and appropriately to the disastrous impact that such a political crisis would otherwise create. If both fiscal and monetary policy were controlled by hyper-extreme politicians, by contrast, then there would be nothing standing in the way of outright disaster.
Even without that 800-lb. gorilla in the room, however, we conclude that the Fed's independence serves extremely important purposes. Ours is not, we hasten to add, an argument for "technocracy all the way down." Whatever one thinks about the role of independent and quasi-independent agencies, we think that the Fed's role is so different and so powerful that it would be a monumental and historic error to listen to the people on the right and the left who want to turn the Fed into more of a politically manipulable actor. We encourage readers to read our article and judge for themselves.