Monetary Policy and Democracy

Should presidents of regional Federal Reserve Banks have a vote on the FOMC, the policy-making committee of the Federal Reserve?

Representative Barney Frank (D-MA) thinks they should not:

I have long been troubled by the anomaly of having officials– selected with absolutely no public scrutiny or confirmation– voting on some of the most important decisions the federal government makes. Therefore, I introduced H.R. 1512, which eliminates the role of the Federal Reserve’s regional presidents as voting members of the Federal Open Market Committee. The Federal Reserve (Fed) regional presidents, 5 of whom vote at all times on the Federal Open Market Committee, are neither elected nor appointed by officials who are themselves elected. Instead, they are part of a self-perpetuating group of private citizens who select each other and who are treated as equals in setting federal monetary policy with officials appointed by the President and confirmed by the Senate.

Would more direct control of U.S. monetary policy by Congress and the President be more consistent with democratic principles than the current system? I can think of several reasons why it might not be.

First, there are some interesting economic arguments why adhering to a long-term commitment to controlling inflation would leave us with something we like better than if we allowed ourselves to decide from scratch the level of inflation that we think we might like for each particular month (see for example Kydland and Prescott (1977) and Barro and Gordon (1983)). An analogy to which some people may be able to relate is the question of how to have the most personal control over your own body shape. If you were to decide anew each day whether you should skip your exercise and add a dessert “just for today”, you might think that such day-to-day discretion gives you more personal control over the outcome than if you were to commit to a diet and exercise regime and completely suppress whatever this day’s impulses might be. But the practical experience of many of us is that the real way to make sure that the outcome is the one you really want is to surrender your own discretion, and instead commit to a policy and stick with it. Many economists argue that the U.S. economy did much better, and that the American public was much more satisfied with the outcome, during the 1990s when monetary policy was more rule-based and less discretionary than what we tried in the 1970s (see for example Taylor 2011).

The election cycle raises a second reason why giving elected officials more direct control over monetary policy need not serve the public’s best interest. By over stimulating the economy today, it might be possible for a president to increase his or her chances in the near-term election. The adverse consequences of that policy may not be perceived by the public until after the election, when it is too late to change the outcome.

Third, historical experience from a number of countries provides ample evidence of what happens when the central bank is allowed to become a key instrument for meeting the government’s bills by just printing more money. Such a system has been a complete disaster wherever it has been tried, and people who have lived through such episodes are pretty enthusiastic about the idea of having a politically independent central bank.

There are a number of details of the institutional structure of the Federal Reserve that try to minimize the direct, short-run political control over the institution. I personally feel it’s a fortunate outcome that the 4-year term of the Federal Reserve Chairman does not coincide with the term of the U.S. President. The 14-year terms of governors of the Federal Reserve (who are nominated by the President and confirmed by the Senate) serve a similar function, though in practice most governors do not serve for a full term. The presidents of the regional Federal Reserve Banks tend to stay in their jobs for longer than the governors, and this provides an important source of stability to policy-making. The fact that they have a regional base that is beyond the control of elected officials in Washington is in my opinion a valuable feature rather than a bug. Besides, the appointed governors and Fed Chairman always have a majority on the FOMC. If the regional banks actually do see things differently than the Washington appointees, their only real power is to issue a dissenting opinion.

On that last issue, however, I feel that Representative Frank raises a valid point:

Finally, one other factor of our current degraded political atmosphere exacerbates this. That is the refusal of the Republicans in the Senate to do their constitutional duty and treat the confirmation process as it is supposed to be treated– namely by looking at the merits of each individual nominee. The influence of the regional bank presidents is obviously great when there are seven governors and five presidents voting on the FOMC. In the current situation, we have an equal vote between the presidents and the governors and that greatly adds not simply to the influence that presidents have, but to their ability to effectively constrain or veto items such as further use of unconventional tools to promote growth.

A separate issue worth mentioning is that just as making a long-term commitment to low inflation can be the best policy in normal times, making a commitment to keep inflation a little higher when the economy initially recovers than the Fed would normally like can be the best policy when the interest rate is stuck at the zero lower bound (e.g., Eggertsson and Woodford, 2003). It’s not clear how easy it will be for the present institutions and personalities to make a nimble adjustment to this alternative form of necessary commitment.

Even so, I think a rational voter should much prefer the existing structure of Federal Reserve decision-making to any proposals that would bring the entity under more direct political control.

Monetary policy and democracy

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