How high for how long? Getting into the Fed’s head

The Federal Reserve is unique, as it was designed to be among the most immune to political interference, compared to other government institutions. It is funded by its own balance sheet operations and the fees it charges, not taxpayer dollars.

The president nominates the Fed Chair and members of its Board of Governors, but appointments must be approved by Congress. Board seats span administrations. Regional Fed presidents are chosen by the local boards and approved by the Board of Governors in Washington.

The Federal Open Market Committee (FOMC) – the policy setting arm of the Federal Reserve – is comprised of the Board of Governors, the Vice Chair, who is always the New York bank president, and four regional Fed presidents. The latter rotate in two- and three-year slots into the voting ranks of the FOMC. All presidents participate in the meetings and contribute to the forecasts that the Fed releases on a quarterly basis.

Congress and a host of internal and external agencies monitor the Fed to prevent fraud and ensure officials are acting in the public’s best interest. That does not mean it is immune to political interference. Many a president has tried to influence the actions of the Fed. Some succeeded better than others, which is one of the reasons the Fed is so adamant about retaining its independence.

The Nixon administration was one of the most successful. It pressured former Fed Chairman Arthur Burns to stimulate the economy to ensure Nixon’s reelection in 1972. Burns is widely considered the worst Fed Chair on record.

That makes what happened next so notable. Burns gave a speech, “The Anguish of Central Banking,” that he repeated many times, starting in 1979. Fed Chairman Paul Volcker was in one of his initial audiences. It made an impression on Volcker and all his successors, whether they know it or not. It acts as a road map for modern central bankers, notably those at the Fed, to conduct policy.

Burns warned:

• Not to bend to “political pressures.” Efforts to loosen monetary policy to boost employment for political gain feed higher inflation and come back to haunt you with even higher unemployment.
• Not to ignore inflationary pressures as they emerge by focusing only on reducing unemployment.
• Act swiftly and aggressively to derail inflation once it flares.
• Avoid stop-start policies aimed at short-term unemployment goals rather than price stability.

Volcker took those lessons to heart and triggered two brutal recessions to break the back of inflation in the early 1980s. That was despite some of the harshest political attacks and public backlash to the Fed in history.

Volcker was effectively pushed out in June 1987. He fought deregulation of the banking industry and raised rates repeatedly to counter the inflation triggered by ballooning federal deficits. Those were not welcome developments by the administration. The transcripts to the May 1987 meeting revealed the extent of the animosity between Volcker and his Board of Governors, which was by then stacked to reflect the administration’s goals.

Alan Greenspan, who was seen as more politically pliable, was nominated to replace him. Financial markets did not welcome his initial appointment, as they feared he would cave to the same political pressures as Burns, his mentor.

Greenspan proved harder to manipulate than many in the administration hoped. Former President George H.W. Bush was particularly frustrated with him during his 1992 reelection campaign. Greenspan was more politically astute than his predecessor and leveraged the press in his favor. He gained near iconic status in the 1990s. He was featured in popular art and landed on multiple magazine covers.

The most notable was Time magazine in February 1999. The caption read, “The Committee to Save the World.” He was flanked by then Treasury Secretary Bob Rubin and Deputy Secretary Larry Summers. They were heralded for their efforts to avert a global financial crisis in response to debt problems in Asia and Russia.

Greenspan was later blamed for fomenting the tech bubble. I was in the room when he forcefully pushed back against a presenter arguing that the Fed should pre-empt bubbles. He countered that there was no way to know the extent of bubbles in the moment and it was better to “mop up” if necessary.

Those comments later came back to haunt him as many blamed the subprime mortgage crisis on the ultralow rate policies that the Fed had pursued in the wake of the tech bubble. The reasons for the subprime crisis are more complex but the Fed is not blameless in the mess that followed.

He was replaced when he retired by Ben Bernanke in 2006, who was tasked with dealing with a much deeper crisis – the global financial crisis of 2008-09. That didn’t stop the political backlash to his actions to stem the bloodletting. I briefed a group of senators in early 2009. They were convinced that Bernanke was more motivated to stimulate to make the newly elected president look better than alleviate the pain on Main Street. That was even though Bernanke served in the administration of the previous president. The economy was imploding; the experience was mind boggling.

Janet Yellen was nominated to succeed Bernanke after his retirement in 2014. She was the first woman chair and came with a longer list of credentials than many of her predecessors. The Senate confirmed her with a vote of 56-26. That was the lowest number of “yes” votes for a Fed chair on record, raising concerns about the depth of Washington’s political divisions.

Lost in translation in the press accounts of her confirmation is that the vote was held on December 20, 2013, the Friday prior to the holiday break, during a snowstorm. Many senators had already left town or didn’t show, as is often the case when it snows in Washington.

She was replaced by her colleague Jay Powell at the end of her term in 2018. Powell suffered brutal attacks from the president as he attempted to normalize rates. He was forced to backtrack in 2019, after the economy came to a near standstill in late 2018. The escalating trade war with China was the primary reason. That illustrates how the Fed must react to the decisions of politicians, despite its determination to stay out of the political fray.