End Double Mandate to Save Fed’s Independence
There’s one prediction that can safely be made about the decision that the Supreme Court will render on the Affordable Care Act: The final vote will almost certainly be along party lines.
The court’s progressive politicization in recent years is a natural reaction to the increasingly activist role it has adopted. As justices have weighed in on questions that were traditionally the province of elected officials -- such as abortion rights -- political institutions have fought back by making ideological orthodoxy a requirement for a Supreme Court appointment.
What’s worse is that a similar dynamic is now occurring at another important U.S. institution: the Federal Reserve Board. In June 2011, Peter Diamond, a Nobel laureate in economics, was forced to withdraw his nomination because of Republican opposition in the Senate. True, his expertise isn’t monetary policy, but was he really so unqualified?
This politicization of the Fed reached a new peak in recent days, with at least one senator saying he would seek to block the confirmation of two new board nominees (one Republican and the other Democrat). I don’t know Jerome Powell (the Republican nominee), but I do know Jeremy Stein (the Democratic one) very well. Even if I don’t agree with him on everything, I couldn’t imagine a wiser, more competent and independent choice to serve at the Fed. So why does his nomination risk being thwarted?
It is common to blame conservatives for this gridlock. That amounts to confusing cause and effect. The truth is that the visceral anti-Fed position of many Republicans is simply a political reaction to the interventionism of the central bank, which in the last decade has overstepped its boundaries.
The lesson of the inflation of the 1970s was that central banks should be independent of the political process in setting monetary policy. As we saw then, elected officials are too often tempted to push for immediate, if temporary, improvement in unemployment at the cost of higher inflation rates down the road. Hence the need for central-bank governors to make decisions free from political pressure.
A separate lesson from the Great Depression, as Milton Friedman and Anna Jacobson Schwartz taught us, is that monetary-policy mistakes can be extremely costly. Hence the need for central-bank governors to be highly competent.
Yet in a democracy, an institution can be independent only as long as it isn’t involved in important political decisions, particularly those with large redistributive effects. Delegating political decisions to an independent technocratic body is better suited to the Chinese model of governance than the U.S. one. We wouldn’t want an independent board to set taxation or public-spending priorities. But that is exactly what the Fed has done over the last decade.
The protracted low interest-rate policy is a tax on savers that wasn’t voted by Congress. The “put options” offered to Bear Stearns Cos. and Citigroup Inc. were subsidies to those banks that were never approved by the political process. More recently, the Fed’s second round of quantitative easing was a gift to wealthy borrowers with good credit ratings that excluded the deserving needy.
To be sure, all these interventions were well intentioned and some were beneficial to the economy. But so are many of the Chinese leaders’ decisions; that doesn’t make them legitimate in a democratic system.
It might be too late to reverse the politicization of the Supreme Court, but Congress can still use its power to save the Fed, namely by passing laws that restrain the central bank’s activism.
The first step would be the elimination of the double mandate. Unlike the European Central Bank, which is in charge only of price stability, the Fed has two main legislated goals: promoting full employment and promoting stable prices.
This gives the Fed too much flexibility, pushing it to substitute for the government in designing economic policy. The temptation to act in this way is particularly strong when Congress is divided and paralyzed. It is precisely this substitution that makes the Fed politically vulnerable. The central bank can be independent or activist; it cannot be both. Independent is better.
(Luigi Zingales is a professor of entrepreneurship and finance at the University of Chicago Booth School of Business and a contributor to Business Class. He is the author of “A Capitalism for the People,” which will be published in June. The opinions expressed are his own.)
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
To contact the author of this story:
Luigi Zingales at Luigi.Zingales@chicagobooth.edu
To contact the editor responsible for this story:
Max Berley at email@example.com