An Overexposed Fed Makes the Chairman's Job Tougher

Photograph by Brendan Smialowski/Bloomberg

Can the Federal Reserve regain its dignity? The summer-long sniping over the selection of a new chairman feels like bad reality television, with Janet Yellen anonymously accused of lacking gravitas and Lawrence Summers pronounced by one senator as unfit to mow his yard. Last year a bill to audit the Fed passed the Republican-led House 327-98 despite warnings from Chairman Ben Bernanke that the auditing of monetary policy decisions could produce a “nightmare scenario” of political interference.

All this is going to make the next Federal Reserve chairman’s job harder. Although the central bank is a creature of Congress, it has long cultivated a reputation for technocratic independence that helps it carry out essential but unpopular missions such as raising interest rates and bailing out banks. As if its normal work weren’t tough enough, now the Fed also has to try to restore its above-it-all image. If the Fed comes to be seen as a politically compromised institution, perception could become reality, warns Tim Duy, a University of Oregon economist who blogs about the central bank. “There is always the possibility that Congress and a like-minded president could rewrite the Federal Reserve Act to reduce monetary independence,” Duy says.

The Fed brought this on itself, at least in part. The extreme measures it took in 2008 and 2009—emergency lending, bailouts, deep rate cuts—saved the U.S. economy from an even deeper downturn, but they alarmed people who thought the bank was overreaching. Former Fed Chairman Paul Volcker said in 2008 that the bank extended itself “to the very edge of its lawful and implied powers” in arranging the emergency takeover of Bear Stearns by JPMorgan Chase.

Republicans went from swooning over Bernanke to stomping on him. In April 2008 Bernanke had the confidence of 61 percent of Republicans and 40 percent of Democrats surveyed in a Gallup poll. A year later 64 percent of Democrats and only 36 percent of Republicans were confident of Bernanke’s economic performance. That probably had something to do with the Fed’s policies and a lot to do with having a Democrat in the White House, says Gallup Editor-in-Chief Frank Newport.

The Fed’s transparency campaign, spearheaded by Bernanke and Yellen, the Fed’s vice-chairman, may also have contributed to its political difficulties. Until 1994 the Fed didn’t reveal its target for the federal funds rate, the overnight borrowing rate it controls. Now it announces that target, plus when it expects to begin raising the rate, along with a target for inflation and a target for the unemployment rate. The chairman even appears at quarterly press conferences, something his predecessors never did.

Instead of clearing things up, all that communication has sometimes bewildered people. In May stocks soared and then plunged after Bernanke’s semiannual report to Congress, in which he tried to convey a nuance about the conditions under which the Fed would begin to taper its $85 billion-a-month bond purchases. “Fed Endorses Stimulus, but the Message Is Garbled,” read the New York Times headline. Observes Duy: “Once you make a misstep, it’s hard to come back from that.”

Part of the Fed’s problem stems from trying to speak to multiple audiences at once. The Fed “normally only talks to investors. But now it needs to also communicate to politicians who use a different language than markets,” Torsten Slok, chief international economist at Deutsche Bank Securities, writes in an e-mail.

The Fed will likely have a harder time showing it can stay above politics if President Obama picks Summers to succeed Bernanke next February. Yellen, the Fed’s No. 2, probably could slide into the job with a minimum of fuss, even though she is on the bank’s dovish wing. Summers raises hackles, in part because of his outsize personality but also because he was a top insider during Obama’s first term, when he was director of the National Economic Council. A Summers-led Fed would inevitably be perceived, especially in conservative quarters, as a political ally of the White House.

Some conservatives think that even Bernanke is working for Obama, deliberately financing the government’s deficits through the Fed’s purchases of Treasury bonds. “It’s pretty hard for me to argue that if you have a few trillion dollars of excess reserves in the banking system, that you think you’re doing it for the good of the economy,” says Allan Meltzer, a conservative economist and historian of the Fed at Carnegie Mellon University. “He’s a fine person. I have nothing personally against him,” Meltzer says. But “there are pressures acting on him that he accedes to.”

Other economists give the Fed more credit. “It consists of a very independent and professional group of economists, very much technocrats,” says New York University economist Mark Gertler. “Because the institution is politically independent they’ve been able to function well, in contrast to virtually every other institution in Washington.”

The Federal Reserve tentatively plans to start raising interest rates in 2015 to keep the economy from overheating. That will hurt its popularity with Wall Street, organized labor, and Democrats in Congress, all of whom like low rates and fast economic growth. “You’ll come under even more pressure when the [rate] tightening cycle is on,” Federal Reserve Bank of St. Louis President James Bullard says. “In some ways it will be even more difficult than the previous five years.” The Fed would also be challenged if there were another financial crisis, because emergency measures to combat it would leave the bank open, again, to accusations that it’s helping special interests. Guiding the economy back to strong, noninflationary and crisis-free growth will be the next Fed chairman’s top priority. It would also be the best way for the bank to regain its political standing—and retreat from the spotlight.


    The bottom line: By trying to talk to several audiences—Congress, investors—at once, the Fed doesn’t always get its message across.

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